What is Cost Overrun?

Dear Mr. Padmakumar,

Greetings,

 A cost overrun, also known as a cost increase or budget overrun, involves unexpected costs incurred in excess of budgeted amounts due to an underestimation of the actual cost during budgeting. Cost overrun should be distinguished from cost escalation, which is used to express an anticipated growth in a budgeted cost due to factors such as inflation.

How to Negotiate a Cost Overrun ?

 You can save money and reduce costs by approaching cost overruns from your suppliers in a structured fashion with a firm base. You may see cost overruns on projects with fixed-price supply contracts, but that doesn't mean you have to pay what your supplier claims. The most effective approach is to establish the facts to determine who is responsible for the additional costs, and then to negotiate a corresponding agreement.

1. Get the Numbers

The first step to negotiating cost overruns is to make sure the total of the overrun includes all the costs associated with the particular cause. Investigate the cause and the related costs yourself to see if the matter is resolved or will continue to generate additional costs. An effective strategy to avoid further costs in the future is to ask the supplier to confirm that the present cost overrun is the final total and to then include such a condition in the negotiated agreement.

2. Increased Scope of Supply

A common cause for cost overruns is an increase in the scope of supply. If the supplier has changed what he is supplying without a request from you, you are under no obligation to pay additional costs. You only have to ensure that what is being supplied still meets your requirements. If you have increased the scope of supply because your needs have changed or because what you requested initially was incorrect, you can expect to pay for the resulting extra costs. Your negotiation should focus on paying a reasonable amount for the extra supply. You can request documentation from your supplier to show what extra costs he has incurred, or perform your own calculations and make the supplier an offer for additional payment. Your aim should be to find a solution that is fair to both parties.

3. Changes in Design

Your approach to cost overruns due to design changes can be similar to those for an increased scope of supply, but negotiations usually are more complicated. An unscrupulous supplier may try to charge substantial extra costs for every minor change. If you identify major design changes and negotiate costs for those, you may be able to settle on a cost package that includes all minor changes. Watch out for design changes caused by suppliers who realize that they can't execute work they way they originally planned. Costs for those changes are the responsibility of the supplier.

4. Problems and Delays

Unexpected problems with a supply can delay delivery and cause cost overruns. Additional costs are associated with extra work for fixing a problem, extra time spent because of delays, interest costs due to late payments and extra costs because the project or materials are not available for use as planned. The negotiations for such costs hinge on the reasons for the problems or the delays. If a supplier caused delays, he may have to pay the costs, but it depends on the details of the contract. Often a rapid cost sharing settlement negotiated on the basis of shared responsibility is in the best interests of both parties.

 What Are Reasons for Cost Overruns in Project Management?

 One of the main functions of project management is to forecast and track costs to avoid cost overruns. While poor execution of project management tasks can lead to increased costs, you can link less obvious reasons to the processes of project management and the underlying nature of complex projects. Effective project management identifies such possible sources of cost overruns early and mitigates their effect.

1. Estimates

A common reason for cost overruns is the inaccuracy of cost estimates. When the bids for subcontracts or the actual costs come in, they are often higher than anticipated. Such cost overruns are due either to incorrect estimates or to changed conditions in the marketplace. You can review cost estimates before placing orders to identify mistakes or changed conditions. An overall review may find that increases in some areas are compensated by decreases in others. You may be able to adjust requirements to reduce costs or seek out lower-cost suppliers. Advising the business owners or managers of possible higher costs at this stage gives them the option of making changes and maintaining their budgets.

2. Design

Sometimes, the designs or drawings that form the basis of the project are not realistic. You may find that a combination of specified features is difficult to achieve or that drawings show an incorrect arrangement. Executing the project as specified will either cost extra or cause problems that must be resolved later at additional cost. As project manager, you have to continuously compare plans with executed work to find such discrepancies early and correct them.

3. Planning

The project progresses according to a plan that assigns durations to project tasks. If the projected durations can be too short, the project take longer than anticipated and cause cost overruns. Monitoring project tasks on the critical path, which is the task sequence from project start to finish that takes the longest to complete, helps reduce the risk of delays. Project tasks off the critical path have slack times, or free times between tasks, that you can use to compensate for delays.

4. Scope

Changes in the scope of supply within a project frequently cause cost overruns. These changes result from new requirements that the owners introduce and fixes for functions that don't work as specified. As project manager, you must make sure the owners understand that additional requirements result in higher costs, which you can classify as improvements rather than cost overruns. When you discover that parts of the project don't work as specified, you must explore different solutions and present them to the owners. Sometimes, you can find acceptable levels of functionality that don't cause cost overruns.

Kind Regards,

Bassam Kassem

Cost overrun refers to a situation in which a project incurs expenses in excess of expected costs outlined in the budget for the project. When a cost overrun happens, this means that the team working on a project has spent all money budgeted for the project. A project that has reached cost overrun requires money in excess of the original budget to complete the work. Cost overruns can happen for a variety of reasons, but they are usually avoidable with careful budget design and project expenditure planning.