The management team is working diligently with the architectural firm and the contractor to get back on budget. You have completed the detail design phase, and cost estimates have come in over the preliminary budget-target approved by the board. You have performed “value engineering” and in fact have made substitutions as well as scope reductions to try to hit the estimated budget. You may have a preliminary guaranteed maximum price from the contractor and are feeling pretty good about the cost estimates of construction now, in light of these reductions, changes, or substitutions. Unfortunately, however, you are still over budget. To hit the mark, the conversation has turned to the idea that you are far enough along to reduce the contingency to get back on budget. With this reduction, you are ready to go to the board with a project update and balanced budget. However, this tactic is sugar-coating and is one of the major reasons management gets in trouble with the board. Don’t fall victim to this easy budget fix – it is not a fix, it is a fake! With this tactic, everything will not go as planned. As a project manager with over 20 years of experience, I have never seen perfection happen. Here are some of the myths you might have been told to justify removing or reducing your contingency (in bold), and why those claims are flawed:
- Cost estimates have been right on so far, and the full contingency will not likely be needed. Guess what? An estimate is an estimate until all bids are in! The construction costs, for example, might look like they are coming in at or under your preliminary budget per square foot, but things can and do go wrong. The four major things that can go wrong are scope creep, actual costs higher than initial costs, certain things will happen, and certain things won’t happen.
- The contractor still has a contingency in his/her GMP or cost estimates. The contractor’s contingency is set aside to cover items that fall within the responsibility of the contractor. Many of the reasons the budget gets busted fall outside the control of the contractor, and the owner must absorb these costs. These include risk events and incomplete design. In addition, some line item costs are called out as allowances. That means that if the true costs exceed the allowance, then the owner is responsible. Without an owner’s contingency you have no wiggle room to cover these actual costs. What happens if you forgot some necessary equipment or didn’t order enough desks or forgot signage? You can’t plan to use the construction contingency. These are soft costs that are the owner’s responsibility, and you are responsible for any overages.
- We still have many opportunities for cost savings as we get further into the project. While you might have opportunities for further cost savings once you get into the project, you are very likely to want to use these savings to restore some of the items you took out early. You probably have a list of value-add items that you’ll want to add back to the project the minute you have some savings. It is more likely that you underestimated costs or forgot a cost, and these are must-haves for which you need to use your contingency.
- We can solve any issues that might come up by managing the cash flow. Don’t let anyone confuse expenditures with cash flow and try to convince you that you can manage expenses using your cash. Cash is what you need to actually pay. The only way you can reduce expenses by managing cash (by timing when you pay the bills) is if you have estimated the cost of financing during construction, and either the rate is lower than planned, you get more gifts (or have costs savings), or the project speeds up and you have fewer months of work for which to include the cost of borrowing during construction. The financing costs during construction represent a very small part of your project and are not likely to yield tremendous cost savings that you can apply to other hard construction costs.
You will face many uncertainties throughout your project. Make sure there is sufficient construction contingency (under control or the contractor) as well as your owner’s contingency (under your direct control). If you are experiencing cost pressures, recognize them and make the necessary adjustments (reduce expenses or increase the budget). Don’t get sucked into the easy way out and reduce the contingency, because you will get stuck!