CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

The growing need for construction of all types coupled with a tight monetary

supply has provided the Oil industry with a big challenge to control cost.

The idea of cost control analysis became necessary as a result of the inability of

companies meeting up with their budget proposals, actual costs during the

execution phase of projects under their scope and the inability of companies to

mobilize excess or dormant funds in some phases of activities and channel them

into needy areas.

According to Mendelson and Greenfield (2009) the remaining part of the twentieth

century would involve corporations, institutions and government in a race to

survive. The attendant dwindling economic fortune of nations’ economies around

the World have geared up the participant in these sectors (the client in particular)

to take up the challenge of ensuring efficient use of their resources to obtain value

for money in terms of performance.

The total cost of construction in normal circumstances is expected to be the sum of

the following cost: Materials, Labour, Site Overheads, Equipment/Plant, Head

office Cost and Profit. But in many parts of the world, particularly in Nigeria, there

are other costs to be allowed for.1

These costs according to Mbachu and Nkado (2007) have obvious negative

implications for the key stakeholders in particular, and the industry in general. To

the client, high cost implies added costs over and above those initially agreed upon

at the onset, resulting in less returns on investment. To the end user, the added

costs are passed on as higher rental / lease costs or prices. To the consultants, it

means inability to deliver value - for - money and could tarnish their reputation and

result in loss of confidence reposed in them by clients. To the contractor, it implies

loss of profit through penalties for non-completion, and negative word of mouth

that could jeopardize his/her chances of winning further jobs, if at fault.

The primary reason for the establishment of cost estimation analysis is to

effectively mobilize savings in the cost effective activities to activities that

required extra cost. (Ohaka, 2005).

Nevertheless, the construction industries require cost estimation

techniques/analysis scheme like other similar schemes aimed at foreseeing the

future of the projects to accomplish the profitability targets.

Due to large operations inherent in the construction industries, managers needed to

imbibe the culture of forecasting activities in terms of costs control techniques in

order to see future at the beginning of the project. These therefore justify the

establishment of Project Control Department were cost controllers and cost

estimators are domicile in the company

2

The proposed work will investigate and report How profitability target could be

achieved using cost control techniques in a construction and also proffer solutions

to how cost can be minimized.

1.2 STATEMENT OF THE PROBLEM

The demand for more construction of all types, coupled with a tight monetary

supply has provided the Oil industry with a big challenge to cut costs. The problem

of high contract costs in all aspects of construction is becoming alarming. Hence,

substantial increases are being observed in Projects of all categories. Today, the

control of materials on construction sites is handled carelessly by planning and

purchasing departments as well as site supervisors and engineers of contractor's

organization. Also, ineffective application of various strategies for controlling

materials cost on sites, by the appropriate personnel in the contractor's team have

been leading to excessive expenditure on materials, which are above the

client's/contractor's budgeted cost (Omotoso, 2006). Improper control of materials

on construction sites has been posing various problems to contractors in realizing

reasonable profit margin. The cost of improper control of materials is borne by the

contractor. This fact is stressed by Omotosho (2006), further stressed that the

higher the level of improper control of materials on sites, and non-compliance or

3

inadequate compliance with the control strategies involved, the higher the loss to

the contractor in terms of profit making.

Abiodun (2002) revealed that it is not only the contractors that bear the brunt of

losses through improper control of materials and ineffective implementation of the

control strategies involved; the suppliers sometimes bear the brunt.

For instance, a number of cement bags, blocks, bricks, tiles, etcetera, which may be

rejected due to mishandling when loading from the source and offloading on site,

will affect the supplier's profit. Also, in the case of labour - only type of contract,

where the client supplies all materials to the site and the contractor only gets paid

for the labour provided, client will be the one to bear the loss.

This research work has been mounted therefore to examine how effective

control of materials which can be delivered through effective implementation of

the control strategies involved, can go a long way in reducing waste, construction

delay, dispute, avoiding substandard work and abandonment, so that Projects can

be executed and completed within reasonable time, cost and to the required quality

standard, thereby ensuring value for money for the client.

1.3 OBJECTIVE OF THE STUDY

This research is aimed at investigating how profitability targets could be achieved,

by studying the control strategies used to control material costs, the effect of cost

4

control techniques on project execution, examine if the material cost control

techniques are properly applied in project execution. More also to examine factors

militating against the application of the cost control techniques in project

execution.

1.4 RESEARCH QUESTIONS

The following research questions have been designed to help the researcher to

carry out this research work:

i) What are the control strategies used to control material cost?

ii) What are the effects of cost control techniques on project execution?

iii) Are the project material cost control techniques being applied in project

execution appropriately?

iv) Are there any factor militating against the application of the cost

control techniques in project execution?

1.5 RESEARCH HYPOTHESIS

The following hypothesis have been designed to guide the research work

i) HO1: Cost control techniques do not significantly affect the profitability

targets from executed projects.

ii) HO2: Cost control techniques do not significantly affect the productivity

of workers in project execution.

iii) Cost control techniques are not applied 5

c) Cost control techniques does not significantly change the profitability of projects

(Ho).

d) Cost control techniques does not significantly differ from cost estimating in

projects (Ho).

1.6 SCOPE AND LIMITATION OF STUDY

This research study is limited to the project activities and services rendered by

Saipem Contracting Nigeria Limited, Port Harcourt. In essence, the scope of this

research is limited to Saipem Contracting Nigeria Limited and their project

activities.

“Call me backs” while collecting data is one of the basic problems encountered

why carrying out this research work. The Human Resources Manager and Project

manager were too busy while this research work was in progress and the researcher

was always calling back on the managers and other staff to be able to get the data

required for the project work.

Also, the instrument used for analysis may not be 100% valid. The researcher

adopted a simple table expressed in numerical terms and percentages which can be

different from one fabrication and installation industry to the other.

Finally, rapid changes in Projects makes most statements made not valid over a

long period of time. The limitations above notwithstanding, the researcher was able

to obtain enough data to make the research work a success.

1.7 SIGNIFICANCE OF THE STUDY

6

The findings of the study would enable Clients, Contractors and Consultants give

an economic approach to construction work such that they would be able to

identify the dominating factors leading to high cost in Saipem contracting Nigeria

Limited.

The application of the solutions proffered to minimizing cost would restore client’s

confidence in consultants, reduce investment risks, and generally boost the

viability and sustainability of the industry

There is no doubt saying that the Projects are the hub of commercial activities in

any economy. This invariably makes a case for the construction especially in the

urban areas.

The cost controllers, cost estimators are in dire need of jobs where their inputs will

be a determinant to the company’s success rather than pursuing crude and obsolete

means.

This research study is therefore important as it is geared towards making the over

50% of the company’s populations domicile in the urban areas to experience a rise

in their standard of living which is yardstick for measuring a nation’s economic

standard. It is hoped that the important recommendations inherent in this research

study will be applied in taking the myriads of problems plaguing Saipem

Contracting Nigeria Limited in particular and other fabrication and installation

industries in general

7

CHAPTER TWO

LITERATURE REVIEW

2.1 COST CONTROL IN CONSTRUCTION

During the execution of a project, procedures for project control and record

keeping become indispensable tools to managers and other participants in the

construction process. According to Dharwadker (2008), cost control can be

achieved by selecting the right man for the right job, the right equipment and tools

for the right work and the right quality of materials, in the right quantity, from the

right source, at the right price and delivered at the right time. Managers are

expected to be well equipped to execute the project, with due consideration to the

quality of work, yet within the estimated cost and limits.

2.2 PROJECT RESOURCES AND CONTROLS

Resource inputs at the project site which produce outputs in the form of work

include: men, materials, machinery and money. The success of a project depends

upon the performance of these input resources when controlling costs

(Hendrickson 2009). The clients should do everything possible to avoid

unnecessary delays as it is one of the leading causes of cost escalation.

8

2.2.1 MATERIALS

One of the big problems on most building sites is the large amount of materials

wastage due to varying circumstances (Butler 2008). This problem requires a

supervisor to constantly be on the lookout for the losses. According to Hendrickson

(2009), wastage of materials can take place during the procurement process,

storage, and during utilisation. Wastage during procurement can result from one or

more of the following causes: buying materials of wrong specifications, buying

more than the actual requirements to cater for unrealistic and unforeseen

eventualities, untimely buying of short-life materials, improper and unnecessary

handling of materials, and wastage in transportation. Wastage during storage can

occur due to the following reasons: damages and breakages during handling,

deterioration due to incorrect storage, incorrect maintenance and short-shelf life

and losses due to fire, thefts/vandalism, and exposure to extreme climatic

conditions. Other causes are lack of pre-work preparation and coordination,

improper accounting and poor storekeeping, negligent and careless attitude of the

supervisor, high rate of deterioration due to long storage at the place of work, and

over-issues from the central stores and failures to return unused surplus materials

to the stores. According to Chitkara (2005), some unavoidable wastages are

inherent during utilisation, but excessive wastage is of concern to the management

as it affects the productivity adversely, with consequences of extra costs. Most 9

problems relating to material wastage revolve around requisitioning and ordering,

receipt and checking of deliveries from suppliers, offloading and handling, storing

and protecting, and issuing, distributing and use of materials.

2.2.2 PLANT

In construction, some tasks are labour intensive, some predominantly employ

equipment, and some use a combination of both. While the actual work done and

the associated labour is accounted by the supervisor concerned, the equipment and

productivity control is undertaken to determine its employment time, the output

achieved, and its productivity at site (Hendrickson, 2009). The main purpose of the

control is to minimize wastage in utilisation so that the overall project cost is not

affected (Chitkara, 2005). Alinaitwe (2006) observed that industrializing

construction would probably reduce the cost of construction by about 30% which

would likely settle the back log of 25% of Ugandans without proper housing.

Labour productivity achieved at the site for a given work provides a measure of the

labourer’s efficiency and effectiveness and the level of site organisation. It shows

the total time for which the labourer was employed at work, the time he was

productive on work and the time he remained unproductive (Chitkara 2005).

Craftsmen use about 40% of available time on productive activities, and about 33%

of the time on non-value adding activities (Alinaitwe 2011). Productive times are 10

wasted for various reasons such as idle waiting, unnecessary travelling, late

starting, early quitting, unscheduled breaks, and delays in the receipt of tolls,

delays to receive materials and work instructions. Assessment of the level of

industrialisation in Uganda and the effect on productivity and other metrics were

done by Alinaitwe, (2011) and the results indicated that the cost of labour is of the

order of 30 to 40% of project costs. The metrics confirmed that labour is a

significant factor in the cost of buildings and more efforts are required to

industrialise the industry. According to Chitkara, (2005) cost control process

involves accounting of actual productivity, and comparing with the standard,

analysing the causes for variations taking remedial measures for improvement.

Raina (2010) emphasises the need for close supervision and good working

relationship.

2.2.3 TIME-COST RELEATIONSHIP

Chitkara (2005) said the relationship between time and cost is a very important

aspect in the control of costs on site as any variation in time has automatic

implication on cost. It is important to report and record all the works involving

materials, plant and labour on sites. This enables the contractor be able to know the

costs and expenses of the resources used on site and compare with the initial cost

budget. Various report techniques used include; daily or weekly and monthly

recording, schedule control, site daily diary report and the project budget.11

2.3 COST FACTORS

A review of literature reveals that there are several factors affecting costs for large

buildings.

In a study of the Nigerian Oil industry, Omoregie and Radfort (2011) sampled the

opinions of Contractors, Consultants and Clients and they discovered 15 factors

responsible for project delays and cost escalation in Nigeria. Their survey revealed

price fluctuation as the most severe cause of project cost escalation which is

attributed to the limitation in exchange rate which in turn affects construction

material prices and general price level.

In another study, Elinwa and Silas (2012) identified 31 essential factors causing

High Cost of Buildings with fraudulent practices and kickbacks ranking second

(2nd) most important factor in Nigeria. Hussain (2009) noted that fraudulent

practices and kickbacks occasioned by greed are perpetuated by some major

players in the Oil industry.

Frimpong, Oluwoye and Crawford (2003), in a review of developing countries

such as Ghana identified some factors as underlying causes of delay and cost over

runs in ground water construction Projects. The five most important factors agreed

by Clients, Consultants and Contractors were monthly payment difficulties from

agencies, poor contract management, material procurement, poor technical

performances and escalation of material prices. 12

Furthermore, a study of the relative weight of ten major causes of business failure

in the United States of America revealed cost related factors as mostly

contributing to business failure. (Kangari,2009). They include: Bad profit,

management incompetence, lack of experience, inadequate sales, loss of market

and economic decline.

2.3.1 EFFECT OF WEATHER

Weather is the most uncontrollable factor amongst the other variables considered.

Temperature and humidity affect productivity of workers. If the temperature and

humidity are high, workers feel lethargic and lose physical coordination

(Frimpong, Oluwoye and Crawford, 2003)

2.3.2. INADEQUATE PRODUCTION OF RAW MATERIALS BY THE

COUNTRY

Ogunlana, Krit and Vithool (2006) noted that the reason for shortage of materials

could be the defective supply of materials occasioned by general shortages in the

industry, poor communication amidst sites and head office, poor purchasing

planning and materials coordination. Nigeria still imports cement when her cement

production potentials surpass any other African country except Egypt and that the

100 % raw materials required for cement production, is readily available in Nigeria

(Eyo -Ita - Eyo, 2011)

13

2.3.3. SUPPLIER MANIPULATION

The major reasons for this factor as observed by Manavazhi and Adhikari (2012)

are monopoly control of the market by some suppliers, work stoppages in factories,

lack of industrialized materials, fluctuating demands forcing suppliers to wait for

accumulation of orders and difficulty in importing raw materials from other

countries.

2.3.4. GOVERNMENT POLICIES

Aibinu and Jagboro (2012) revealed that Government deregulation policies aimed

at liberalizing the economy since 1986 are responsible for the instability in prices.

It is therefore not surprising that fluctuation claims during these periods contribute

significantly to additional cost.

2.3.5. Contractor’s cartel

According to Omole (2006), the major Projects like heavy engineering, super

highways and general infrastructure can only be undertaken in Nigeria by a few

contractors. These contractors know themselves and therefore an indirect cartel is

formed. The contractors on tendering are in a vantage position to decide amongst

themselves who gets which contract and at what price. What appears on tendering

to be the lowest tender may be over 20% - 30% above the actual value of the job.

14

2.3.6. INCORRECT PLANNING

Incorrect planning is one of the most important factors that affect cost of

construction. Contractors must be aware of all resources that he might need for any

project. The contractors, also, should utilize all resources in an efficient manner.

Proper scheduling is the key to utilizing project resources, if not, the project cost

will increase.

2.3.7. DESIGN CHANGES

This problem arose form inadequate project planning and management of the

design process. A quite distinctive example is the progress of West African Gas

Pipeline (WAGP). Asamoah (2012) reported that WAGP project has suffered a

number of setbacks, culminating in the escalation of its cost from an initial US

$500 million. One of the problems includes the changing of the initial plans to lay

the pipeline offshore to an onshore configuration.

2.3.8. FRAUDULENT PRACTICES AND KICK BACKS

This factor was the second most important factor affecting cost in Nigeria as noted

by Elinwa and Silas (2009). Hussein (2008) also noted that fraudulent practices

and kick backs occasioned by greed are perpetrated by some major players in the

Oil industry. The perpetrators of this act in the industry are predominantly found

15

within the rank and file of contractors, consultants and public clients as evident

from the report published by TELL (2002).

2.3.9. POLITICAL INTERFERENCE

Omole (2006) reveals that 80 percent of the contractors in Nigeria are indigenous

companies. The government agencies, in most cases are teleguided by the political

heavy weight to award contract to party stalwarts at very high prices.

2.3.10. RELATIONSHIP BETWEEN MANAGEMENT AND LABOUR

There is always a gap between the project management and labour.

This gap should be kept as small as possible, so that the relationship between

management and labour may be strengthened. They should work as a team to build

a project with minimum cost.

2.3.11. CONTRACT MANAGEMENT

Poor contract could be attributed to the manner in which contracts are awarded. In

most cases Projects are awarded to the lowest bidder (Mansfield, Ugwu and Doran,

2008).

Some of these low bidders may lack management skills and have less regard for

contract plans, cost control, over all site management and resource allocation. As

we know in the case of Nigeria, contracts are usually awarded to politicians and

well connected individuals irrespective of the apparent deficiencies in their

relevant delivery potentials.16

2.3.12. LACK OF COORDINATION BETWEEN DESIGNER AND CONTRACTORS

Contractors construct the project according to the project design. Normally, if the

design has any mistakes, the contractors may apply the mistakes without knowing

there are mistakes or without notifying and coordinating with the designer or the

client.

2.3.13. COST OF MATERIALS

Material price is subject to supply and demand and is affected by many other

things, including quality, quantity, time, place, buyer and seller.

Other factors affecting material cost include: currency exchange, low or high

demand, material specification, inflation pressure and availability of new materials

in the country.

2.3.14. ADDITIONAL WORK

Additional work is related to design changes, which is due to lack of detailed

briefing on the functional and technical requirements of the Projects by the clients

(Mansfield et al, 2008).

2.3.15. POOR FINANCIAL CONTROL ON SITE

Controlling the project financially on site is not an easy task .All resources need to

be controlled: labour productivity, material availability, material waste, good and

effective methods, using effective tools, equipment, good project planning and

scheduling.17

2.3.16. DISPUTES ON SITE

Dispute is a major obstacle for any project. Normally disputes will exist if work

does not match the contract document or if work is not included in the contract

document. Any dispute will eventually delay the project and increase project cost.

2.3.17. FLUCTUATION OF PRICE OF MATERIALS

Omoregie and Radfort (2009) surveyed contractors, consultants and public clients

and revealed price fluctuation as the most severe cause of project cost escalation in

Nigeria. This could be attributed to the limitation in exchange rate which in turn

affects construction materials prices and the general price level.

2.3.18 CONTRACT PROCEDURE

The contract document is the ground rule between all parties (contractors,

consultants and clients).One part of the contract document is the contract

procedure.

The contract procedure shows the type of contract, payment procedure constraints

and regulations within the contract. The type of contract affects the Projects

because of the risk involved in some types of contract(i.e. lump sum).Unclear

contract procedures will lead to disputes, project delay and cost overrun (Fisk,

2012)

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2.3.19. WRONG METHOD OF ESTIMATION

This factor could be attributed to the unpredicted inflationary trend, lack of

adequate training and experience at the senior management level, and fraudulent

practices Mansfield et al (2008)

2.3.20. WASTE ON SITE

It seems that the little waste of construction material on site should have a very

minor effect on the total material cost. However, this minor effect can reach up to

50 % of the total material margin of a project. So waste on site has to be

considered on tendering any project (Elinwa and Silas, 2013)

2.3.21. TRANSPORTATION COST

As the government increases the price of fuel, transportation companies raise the

cost of their services to cover the fuel increase and that obviously translates to an

increase in transportation cost.

2.4 COST MANAGMENT

For a project, cost management is an extremely important element of project

management to run it successfully. The management of costs is commonly

reflected in company’s strategic goals, mission statements and business plans of a

project organization in many ways.

There are three main functions to support companies’ cost system performance.

19

First, financial reporting function which is the system that present production

expenses in reports covering each period of interest such as cost of goods sold and

in inventory. Secondly, cost system can give the employees and operators

economic feedback, such as process efficiency and expense control. Finally,

according to cost information, companies can estimate the costs of products,

services, activities and customers for better control.

2.4.1 DIRECT COSTS AND INDIRECT COSTS

Costs can be divided into two main types: direct costs and indirect costs.

1. Direct costs

Direct costs are directly generated by the project. The cost of labor and materials

could be the best examples of direct costs. Generally, labor costs are viewed as

direct cost because of its relevance to the workers who actually are involved in the

project.

However, some labor costs might not be considered as direct costs for the project

such as the costs of support personnel. For example, the costs of accountant or

consultants that come from other organizations may not be allocated directly and

integrated as a part of the project, especially when their duties are servicing or

monitoring something that could be seen as extra in some sense.

To a project, the direct cost of materials is easy to calculate, as long as the types of

material required to accomplish the project are known. For instance, the direct 20

costs of building a library or holding a party for 100 people can be estimated with

fair accuracy, meaning these costs can be pinpointed in the project directly in a

systematic way.

Historically, to some industries like manufacturing, the costs of two resources were

applied to Projects directly and those were material costs and labor costs. There are

some reasons why these resources were assigned directly. First of all, these kinds

of costs accounted for a great number of the costs of the final product. Second, the

perspective of scientific management movement believed that making the usage

and consumption of these expensive resources under control was seen as very

important.

Finally, it was easy to measure the consumption of these kinds of resources by

each product. These three characteristics can justified the measurement costs for

estimating how much materials and how much labor will be spent on each product.

2. Indirect cost

Indirect costs are generally linked to two features, overhead cost and selling and

general administration cost. The former refers to all sources of indirect materials,

utilities, taxes, insurances, properties and repairs, depreciation on equipment, and

health and retirement benefits for the labor force. They could be quite complicated

to estimate as the costs could derive from different Projects and different works

within a company. Selling and general administration costs usually refer to 21

advertising, shipping, salaries, sales and secretarial support, sales commissions and

similar costs.

Tracking and relating these costs to Projects is not nearly as forthright compared

with the direct costs, so the procedures applied are different from organization to

organization. Measurement approaches could include flat rate (such as a

percentage multiplier from 20% to over 50% on top of direct costs) which is a way

to estimate the cost relative to the direct costs of a project framed as overhead

costs, or a project-by-project-basis-measurement which is based on individual

analysis.

2.4.2 COST MANAGEMENT SYSTEM

The main purpose of the cost management system is to maximize profits. In order

to maximize profits, the company has to face and succeed competitions that come

from either domestic or international companies, and to develop themselves

continually. In a nutshell, the two primary objectives to provide a cost management

system are global competition and continuous improvement.

22

Figure 2.1 Cost Management Systems

As illustrated in figure1, a cost management system needs: support and

commitment from senior management; the workers involvement in different

positions; and a self-perpetuating system of improvement which might help the

company to improve value added activities and decrease non-value added

activities.

2.5 WAYS OF MINIMIZING COST

There are several ways in which cost of construction can be minimized. Fisk

(2013) reveals two cost reduction measures. The first is the application of a value

engineering concept, which aims at a careful analysis of each function and the

elimination or modification of anything that adds to the project cost without adding

to its functional capabilities. He argues that by carefully investigating costs, 23

availability of materials, construction methods, procurement costs, planning and

organizing, cost / benefit values and similar cost influencing items, an

improvement in the overall cost of project can be realized. The second is to provide

comprehensive and error free designs and specifications to avoid misinterpretations

by the contractor or delay due to missing details.

According to Cooke and Williams (2011) recommended as cost reduction

measures the elimination In addition, Ashworth (2010) observed that profitable

firms may be generating their revenues from the elimination of waste at both

professional and trade practice levels.

Cost reduction measures also include: establishing firmly the requirements and

features of the project at the onset before getting started, preparing the project team

to do its best by getting members to sign off on capabilities and responsibilities,

staying diligent about keeping the project the project on the right path through

contract clauses that disallow significant changes once the project is underway,

effective human resource management or minimization of design / specification,

delivery and site wastes through the formulation and implementation of effective

material policy and material management. Through effective motivation, and

project tracking involving discerning early what area or paths are leading to dead

ends and applying early corrective actions.

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2.6 COST PERFORMANCE

“Cost is among the major consideration throughout the project management life

cycle and can be regarded as one of the most important parameters of a project and

the driving force of project success” (Azhar et al., 2008: : 7). Gido and Clements

(2003) mentioned that cost performance is an effective technique in project

management effort expended and it is widely accepted in the literature and

industry. Earned Value Analysis (EVA) is used to evaluate cost performance of

different types of Projects. Cost control, cost estimating, and cost budgeting are

three cost related processes that interact among each other and with other scopes of

construction Projects.

Besides that, Gido and Clements (2003) stated that there are four cost-related

measures in cost performance analysis which are used to analyze cost performance

of a project. The measure is used to evaluate the project whether the project is

being performed within the budgeted cost or whether it is in line with the actual

cost. The four cost-related measures are TBC (total budgeted cost), CBC

(cumulative budgeted cost), CAC (cumulative actual cost), and CEV (cumulative

earned value). Normally, cost estimation will be made before start a project so that

it can be controlled within cost budget. A project may require more than one

person and may occur more than once during the life of a project which depending

on the complexity of the project. It may be very simple or extremely complex 25

when managing the cost of project. In project management, it should also consider

the needs of project stakeholders in the project cost (Gido antd Clements, 2003).

It found that it is important to studies more detail on costs of building and it is

agreed by Ashworth (2009) found that “cost studies of buildings consist of the

application of the techniques and expertise of economics to construction Projects ”.

Also, it is to ensure available resources are used efficiently and to increase the rate

of growth of construction work in the most efficient manner

2.7 COST OVERRUN

Cost overrun is a very common phenomenon and majority Projects in Oil industry

facing this problem. Cost overrun occurs when the final cost or expenditure of the

project exceeds the original estimation cost, Avots (2013). Angelo and Reina

(2012) pointed out that cost overrun is one of the main problems in Oil industry.

The problem may found in both developing and developed countries. This problem

is quite serious and futher study on this issue is needed to reduce the problems.

There are some factors contribute to cost overrun in Oil industry which are found

from the researchers’ study. The factors are as follow:

2.7.1 INACCURATE OR POOR ESTIMATION OF ORGINAL COST

Peeters and Madauss (2008) stated that the biggest factor that contributes to

overruns of budget is inaccurate estimation of original or initial cost of a project. It

26

is because of technical problem on how to estimate project costs and also not

enough project information in the early stage of project.

2.7.2 INFLATION OF PROJECT COST

Harrison (2008) stated that inflation of project costs cause increasing of costs.

Inflation of materials, equipments, and labours costs may vary geographically

within a country, from country to country, and contracts of subcontractors with

suppliers may involve different inflation protection terms that agreed with a client.

As inflation goes up, interest rates will go up and the costs will increase too.

2.7.3 IMPROPER PLANNING

According to Frimpong (2003), improper planning and management experience

limitation caused failures of using technical. The processes to produce a product

become slower and take longer period to complete the project.

2.7.4 FLUCTUATION IN PRICE OF RAW MATERIALS

Price fluctuation causes cost overruns in most cases where it is hard to estimate the

cost accurately because it is objective. This happen caused by high inflation of

price in developing countries or the speculation of suppliers (Long et al., 2008).

2.7.5 POOR PROJECT MANAGEMENT

Poor of site supervision and management and poor project management assistance

contribute to problem of cost overrun in construction Projects. Poor of site

27

management reflected the weakness and incompetency of contractors. Skilful and

experience human resource is insufficient in site management (Long et al., 2008).

2.7.6 LACK OF EXPERIENCE

Chan and Park (2005) found that most of the contractors are lack of experience

especially in financial management. The distribution of the costs do not plan well

in the Projects. It might cause over of costs budgeted.

2.7.7 OBSOLETE OR UNSUITABLE CONSTRUCTION EQUIPMENTS

AND METHOD

Obsolete and unsuitable equipments and methods cause the progress of

construction works become slower. Some countries try to import or transfer the

modern technology into their countries. However, the method is unsuccessful

because lack of skilful human to operate the technology (Long et al., 2004a).

2.7.8 UNFORESEEN SITE CONDITIONS

Nega (2008) found that actual site conditions of a project are not usually

determined until excavation is completed. It is sometimes possible that site

conditions are overlooked by the initial review or conditions have changed due to

change of weather conditions or subsoil conditions. The unexpected conditions on

sub surface sometimes require fundamental redesign of Projects with high expense.

Changes of site conditions become a problem for machinery and supplies to move

in and out of the site. This also increase costs required.28

2.7.9 MISTAKE IN DESIGN

According to Long et al. (2008), mistakes in design or poor design are caused by

the low competence designer. The approval design or drawing process becomes

low quality and ineffective especially for those with government-funded Projects.

The unrealistic design which found after the start the construction Projects has to

change and it could lead to cost overrun.

2.7.10 INSUFFICIENT FUND

Long et al. (2008) noted that delay of the Projects followed by cost increasing to

cover all the expenses during construction. Owners are not preparing sufficient

fund for project and pay on time as shown in contract agreement to contractor.

2.7.11 POOR CONTRACT MANAGEMENT

Ogunlana and Olomolaiye (2009) mentioned that many contractors in developing

countries have organizes their own commercial undertaking. They are good in

managing expense because they are familiar with the business of making money.

They pay low wages, submit low bids and low ability to plan and coordinate

contracts. They do not follow the agreement that stated in contract.

2.7.12 HIGH COST OF MACHINERIES

Chan and Park (2005) found that high cost of machineries is one of the market

related problems. Oil industry is mainly market driven where it is influenced by

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current market style. For example, when the oil needed to run machineries

increasing, the rental cost of machineries also increasing.

2.7.13 COST UNDERESTIMATION

In order to get project approval for the project, some parties have deliberated

underestimating of costs for their project. It is quite serious situation that occurred

on some project (Nega, 2008).

2.7.14 MEASURES TO CONTROL COST

There are some measures which are found from the researchers’ study to control

the cost s or to overcome the problems of cost overruns. The researchers have their

own opinion on how to solve the problems. The measures are as below:

2.7.15 PROPER PPROJECT COSTING AND FINANCING

Kaliba et al. (2009) stated that delays of schedule may occur caused of delayed in

payments due to complex financial processes in client organisations. Delay in

payment would cause financial difficulties to contractors and subsequently delay

the schedule to complete the activities on site. Interest could be charged on delayed

payments hence inducing cost overruns in the project.

2.7.16 COMPETENT PERSONNEL

Kaliba et al. (2009) mentioned that contractors, consultants, and clients should

ensure that they have the right personnel with appropriate qualifications to manage

30

their Projects efficiently. It is better if construction manager have experience and

qualifications in project or construction management.

2.7.17 APPROPRIATE SCOPE DEFINITION

Nega (2008) agreed that only concern on the works required completing the project

successfully. Guard against incomplete identification of scope is important to avoid

frequent changes. Also, do not incorporate the works out of scope to avoid

unnecessary works.

2.7.18 PROPER COST CONTROL

Ashworth (2009) mentioned that one of the client’s requirements in respect of

construction project is assessment of its expected cost. Proper cost control is

important as it is the general trend towards greater cost-effectiveness and ensures

costs not solely in the context of initial costs, but in terms of life-cycle costs or

total cost appraisal.

2.7.19 RISK MANAGEMENT DURING PROJECT EXECUTION

Peeters and Madauss (2008) found out some approach to avoid cost overruns. In

any development project, there must be contain certain amount of risks. Therefore,

a risk management function needed to be performed by project manager to

determine and reduce the risks of the particular project. The aim of risk

management is to minimise any risk that might result failure to meet the project

requirements.31

2.8 COST AND TIME GROWTH OF PROJECT CONSTRUCTION

Construction projects are notorious for running over budget and time Hester et

al.2011; Zeitoun and Oberlander 2013; Ibbs and Allen 2005. Change orders have

been found to be a major contributor to time and cost overruns Jahren and Ashe

2009, yet the impact that rework has on the cost and time performance of projects

remains unexplored in the construction management literature. Hence, supervisors

always learn details of projects so that cost and schedule growth could be

calculated for each project.

2.9 FORECASTING OF COST AND TIME IN OIL INDUSTRY

The nature of Oil industry is to be profitable in extremely competitive

environment. More specifically, the construction environment is continuously

changing and resulted to uncertain variable in project data. As a consequence,

Project Manager faced with performance problem in determining the accurate

project performance. In attempting to gain better profits, Project Manager needs to

make timely and informed decision. However, today’s deficiencies in monitoring

and control of project operation unable Project Manager to manage project

effectively and resulted to major cause of project failure (Al-Tabtabai 2006). When

controlling project performance, Project Manager should not only monitor cost and

time variances for actual project progress, but also to properly establish the actual

project status based on objective predictions of final project performance. At 32

completion project performance can be predicted by comparing estimates of

planned total budget and final duration with their respective most likely forecasted

values (Ahuja et al. 2011). This, however, are necessary for Project Manager to

determine if corrective actions are required to minimize the expected variances

from planned performance Thus, forecasting is needed to predict the project

performance at completion based on current performance.

2.10 SIGNIFICANCE OF COST AND TIME FORECASTING IN THE OIL

INDUSTRY

In reality, the original estimates may be considered the first project forecast and, at

the point of project completion, the latest updated estimate (last forecast) and the

actual amount of what is being expended should be the same (Barazza et al 2004).

In controlling a construction project, Project Manager should understand the

importance of using project baselines which serves as a benchmark. This is to

ensure the project is running smoothly and early indication on deficiencies of

project can be identified. Thus, necessary corrective action can be made in due

time.

In current practice, project baselines or planned S-Curves is used to determine

variances in cost or schedule and to measure the earned value. In this context, it

explains why this method is widely used in Oil industry to measure the

performance of Projects. One of the advantages of this method is that it can 33

identify any cost and schedule variances at the end of the project. However, there

is still lacked within this method of providing corrective action plans if negative

variances is identified. Therefore, the needs of forecasting performance variances

at completion is necessary to Project Manager in order to decide the suitable

corrective action plans and the effect on final project performance (Crandall et al

1982).

2.11 PROJECT TIME-COST RELATIONSHIP

Total project costs include both direct costs and indirect costs of performing the

activities of the project. Direct costs for the project include the costs of materials,

labor, equipment, and subcontractors. Indirect costs, on the other hand, are the

necessary costs of doing work which cannot be related to a particular activity, and

in some cases cannot be related to a specific project (Davison 2003).

If each activity was scheduled for the duration that resulted in the minimum direct

cost in this way, the time to complete the entire project might be too long and

substantial penalties associated with the late project completion might be incurred

(Dlakwa 2008). Thus, planners perform what is called time-cost trade-off analysis

to shorten the project duration. This can be done by selecting some activities on the

critical path to shorten their duration.

As the direct cost for the project equals the sum of the direct costs of its activities,

then the project direct cost will increase by decreasing its duration. On the other 34

hand, the indirect cost will decrease by decreasing the project duration, as the

indirect cost are almost a linear function with the project duration (Khalil et al

2097).

2.12 REWORK COSTS

Various interpretations of rework can be found in the construction management

literature. For example, terms such as quality deviations Burati et al. 2007,

nonconformances Abdul-Rahman 2008, defects Josephson and Hammarlund

2009 !, and quality failures Barber et al. 2007 are often used, though these

definitions vary. Ashford 2012 defines rework as ‘‘the process by which an item is

made to conform to the original requirement by completion or correction.’’ The Oil

industry Development Agency 1995, however, defined rework as ‘‘doing

something at least one extra time due to nonconformance to requirements.’’

Essentially, rework can result from errors, omissions, failures, damage, and change

orders throughout the procurement process Love et al. 2006; Love and Li 2008.

Josephson and Hammarlund 2009 reported that the costs of residential, industrial,

and commercial projects range from 2 to 6% of their contract values. Similarly,

Love and Li 2008 in their study of rework costs for a residential and industrial

building found the costs of rework to be 3.15 and 2.40% of contract value,

respectively. In addition, Love and Li 2008 found that when a contractor

implemented a quality assurance system in conjunction with an effective 35

continuous improvement strategy, rework costs were found to be less than 1% of

the contract value. The costs of quality deviations in civil and heavy industrial

engineering projects, however, have been found to be significantly higher. Burati

et al. 2007 studied nine major engineering projects to determine the cost associated

with correcting deviations to meet specified requirements. The results of their

study indicated that, for all nine projects, quality deviations accounted for an

average of 12.4% of the contract value. A significantly lower figure was reported

by Abdul-Rahman 2008, who found nonconformance costs excluding material

wastage and head office overheads! in a highway project to be 5% of the contract

value. Abdul-Rahman 2008 specifically makes the point that the nonconformance

costs may be significantly higher in projects where poor quality management is

implemented.

Notably, Nyle´n 2006 found that when poor quality management practices were

implemented in a railway project, quality failures were found to be 10% of the

contract value. Nyle´n 2006 further found that 10% of the quality failures

experienced accounted for 90% of their total cost. Here, significant proportions

76% of the quality failures were attributable to design-related issues, such as

erroneous documentation and poor communication between project team members.

As mentioned above, rework can also originate from change orders Knocke 2009;

Love and Li 2008. However, the extent to which change orders contribute to 36

rework costs remains relatively unexplored. Research undertaken by Zeitoun and

Oberlander 2011 found that the median costs of change orders for 71 fixed price

projects were 5.3% of the contract value and 6.8% for 35 cost reimbursable

Projects . Similarly, research undertaken by Cox et al. 2009 in the U.K. revealed

that the costs of design-related change orders could range from 5 to 8% of the

contract value, even when projects are managed effectively, as most of the changes

are initiated by clients. The costs of change orders in the research reported by

Zeitoun and Oberlander 2011 and Cox et al. 2009 are similar to the rework costs

previously reported. A degree of change can be, and to a certain extent, should be

expected in construction, as it is difficult for clients to visualize the end product

that they procure. However, almost all forms of rework with the exception of that

caused by weather are preventable, since poor management of the design and

construction process typically causes such costs to occur.

2.13 IMPACT OF COST CONSIDERATION

When a modification is directed, the settlement of that modification includes not

only the cost and time change of the work directly affected but also the cost and

time impact on the unchanged work. The impact portion on unchanged work of a

modification is very difficult to determine. The scope of impact is very broad,

intangible, and susceptible to a large variety of situations (Ogunlana and

Olomolaiye 2008). Both continue to add that by far the greatest portion of impact 37

costs results from acceleration or delays. In general, when delay effect can be

minimized, impact costs are reduced. Through the present, at least, impact costs

have been determined on a case-by-case basis for each particular situation. Very

few claims for impact are denied in their entirety. It is, therefore, necessary that the

claim be reviewed for validity by a team involving all-around expertise.

Impact costs are generally first presented by the contractor as "claimed" impact

cost as part of the proposal. The support for such “claimed” cost should also be

obtained and includes narrative, calculations, and planned rescheduling. To

determine the extent of the impact, the existing network schedule furnished by the

contractor must be developed to reflect actual construction as accurately as

possible. The modification work must be superimposed upon the original network

schedule in such a manner to minimize delay under the given requirements. The

revised network must then be thoroughly reviewed relative to the existing job plan

(Davison 2003).

This comparative review should indicate those areas that have been affected by the

modification. Once identified, each construction task must be analyzed for impact

and estimated judgmentally considering the influences caused by the change. Each

impact cost claimed should be classified as either factual or judgmental. The

factual costs are those which are fixed and established and can be determined

directly from records. These include rental agreements, wage rate agreements, 38

purchase documents, etc. Once the item has been determined to be valid as a

factual impact, the item cost may be directly calculated. The amount of cost change

is either stated on the certification document or can be determined from the

scheduled time change of the construction progress plan (Christensen et al 2005).

Impact costs considered factual:

• Escalation of material prices

• Escalation of labor wage rates

• Change in equipment rates

• Increase from extending the storage period for materials and equipment

• Increase from extending the contract for labor cost and subsistence

• Increase from a longer period of equipment rentals or use

• Increase from a longer period of utilizing overhead personnel, materials, and

utilities

• Increase from a longer period of providing overhead and project office services

Judgmental costs are those that are dependent on variable factors such as

performance, efficiency, or methodology and cannot be stated factually prior to

actual accomplishment. These must be negotiated and be based upon experienced

judgments. Judgment or costs can be challenged but cannot be found erroneous if 39

based on reasonable judgments of the conditions. Since judgmental factors appear

in the Government estimate and the contractor's proposal, results of negotiations

often depends on credibility and clarity of support documentation. When each

impacted activity can be analyzed for cost separately, the estimate of impact should

be prepared accordingly. However, sometimes the impact items are so interrelated

that it is best to develop a detailed plan for accomplishing the total remaining

revised contract work (Davison 2003).

Each remaining item in this plan would be coasted at the productivity and rate in

effect at the time the work is to be accomplished and the cost incurred. The same

scope of work under the original plan would also be separately costed at the

productivity and rates in effect at the originally scheduled time. The net difference

from the totals of these two estimates yields the cost of impact. Whatever the

method used, those impacts determined valid must be included and costed by the

most accurate method available. The estimator should avoid including questionable

impact costs in the initial government estimate unless each has been found to be

justifiable (Dawood et al 2007).

2.14 SUMMARY

In conclusion, the main factor affecting cost of construction as opined by the three

key players in the Oil industry is cost of materials. Since Quantity Surveyors are

40

cost experts they are in the unique position to examine these factors and take care

to estimate, include contingencies in the budget, plan for, and mitigate the adverse

effects of these factors on the project cost. Clients, Contractors and Consultants

should give an economic approach to construction work such that they would be

able to identify the dominating factors leading to high cost of construction in

Nigeria and apply the proffered solutions to minimizing same so as to restore

client’s confidence in consultants, reduce investment risks, and generally boost the

viability and sustainability of the industry.

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