Project Management for Construction

Fundamental Concepts for Owners, Engineers, Architects

and Builders
1. The_Owners'_Perspective
2. Organizing_For_Project_Management
3. The_Design_And_Construction_Process
4. Labor,_Material,_And_Equipment_Utilization
5. Cost_Estimation
6. Economic_Evaluation_of_Facility_Investments
7. Financing_of_Constructed_Facilities
8. Construction_Pricing_and_Contracting
9. Construction_Planning
10. Fundamental_Scheduling_Procedures
11. Advanced_Scheduling_Techniques
12. Cost_Control,_Monitoring,_and_Accounting
13. Quality_Control_and_Safety_During_Construction
14. Organization_and_Use_of_Project_Information

by Chris Hendrickson, Department of Civil and Environmental Engineering,

Carnegie Mellon University, Pittsburgh, PA l52l3 Copyright C. Hendrickson 1998

First Edition originally printed by Prentice Hall, ISBN 0-13-731266-0, 1989 with
co-author Tung Au.

Second Edition prepared for world wide web publication in 2000.

Version 2.2 prepared Summer, 2008.

Preface

This book is provided on the worldwide web as a service to the community of

practitioners and students. Reproduction for educational purposes is permitted with
appropriate citation. If you find this work helpful or have suggestions for additions
or corrections, please email Chris Hendrickson: [email protected]. A hardcopy
Instructor's Manual with problem solutions is available for a fee of $ 10 to cover
reproduction, mailing and handling. Send a check made out to Carnegie Mellon
University to Ms. Patty Langer, Department of Civil and Environmental
Engineering, Carnegie Mellon University, Pittsburgh, PA 15213.

This book develops a specific viewpoint in discussing the participants, the

processes and the techniques of project management for construction. This
viewpoint is that of owners who desire completion of projects in a timely, cost

1
effective fashion. Some profound implications for the objectives and methods of
project management result from this perspective:

• The "life cycle" of costs and benefits from initial planning through operation
and disposal of a facility are relevant to decision making. An owner is
concerned with a project from the cradle to the grave. Construction costs
represent only one portion of the overall life cycle costs.
• Optimizing performance at one stage of the process may not be beneficial
overall if additional costs or delays occur elsewhere. For example, saving
money on the design process will be a false economy if the result is excess
construction costs.
• Fragmentation of project management among different specialists may be
necessary, but good communication and coordination among the participants
is essential to accomplish the overall goals of the project. New information
technologies can be instrumental in this process, especially the Internet and
specialized Extranets.
• Productivity improvements are always of importance and value. As a result,
introducing new materials and automated construction processes is always
desirable as long as they are less expensive and are consistent with desired
performance.
• Quality of work and performance are critically important to the success of a
project since it is the owner who will have to live with the results.

In essence, adopting the viewpoint of the owner focuses attention on the cost
effectiveness of facility construction rather than competitive provision of services
by the various participants.

While this book is devoted to a particular viewpoint with respect to project

management for construction, it is not solely intended for owners and their direct
representatives. By understanding the entire process, all participants can respond
more effectively to the owner's needs in their own work, in marketing their
services, and in communicating with other participants. In addition, the specific
techniques and tools discussed in this book (such as economic evaluation,
scheduling, management information systems, etc.) can be readily applied to any
portion of the process.

As a result of the focus on the effective management of entire projects, a number of

novel organizational approaches and techniques become of interest. First and
foremost is the incentive to replace confrontation and adversarial relationships with
a spirit of joint endeavor, partnership and accomplishment. For example, we
discuss the appropriate means to evaluate risks and the appropriate participants to
assume the unavoidable risks associated with constructed facilities. Scheduling,
communication of data, and quality assurance have particular significance from the
viewpoint of an owner, but not necessarily for individual participants. The use of
computer-based technology and automation also provides opportunities for

2
increased productivity in the process. Presenting such modern management options
in a unified fashion is a major objective of this book.

The unified viewpoint of the entire process of project management in this book
differs from nearly all other literature on the subject. Most textbooks in the area
treat special problems, such as cost estimating, from the viewpoint of particular
participants such as construction managers or contractors. This literature reflects
the fragmentation of the construction process among different organizations and
professionals. Even within a single profession such as civil engineering, there are
quite distinct groups of specialists in planning, design, management, construction
and other sub-specialties. Fragmentation of interest and attention also exists in
nearly all educational programs. While specialty knowledge may be essential to
accomplish particular tasks, participants in the process should also understand the
context and role of their special tasks.

This book is intended primarily as a text for advanced undergraduates, beginning

graduate students or professionals continuing their education in engineering,
construction, architecture or facilities management. Examples and discussion are
chosen to remind readers that project management is a challenging, dynamic and
exciting enterprise and not just a record of past practices. It should also be useful to
professionals who wish an up-to-date reference on project management.

Chapters 1 to 3 present an overview of the construction management and design

process which should be of interest to anyone engaged in project management for
construction. One need not have detailed knowledge about individual tasks or
techniques for this part. Individuals can read these chapters and understand the
basic philosophy and principles without further elaboration.

Chapters 4 through 14 describe specific functions and techniques useful in the

process of project management. This part presents techniques and requirements
during project planning, including risk assessment, cost estimation, forecasting and
economic evaluation. It is during this planning and design phase in which major
cost savings may be obtained during the eventual construction and operation
phases. It also addresses programming and financing issues, such as contracting
and bidding for services, financing, organizing communication and insuring
effective use of information. It further discusses techniques for control of time, cost
and quality during the construction phase. Beginning courses in engineering
economics (including cash flow analysis and discounting), use of computers,
probability and statistics would be useful. Furthermore, access to a personal
computer with spreadsheet or equation solving software would be helpful for
readers attempting some of the problems in Chapters 4 to 14. Numerous software
programs could be used for this purpose, including both spreadsheet and equation
solving programs. Problems in some chapters could also be done on any number of
existing software packages for information management and project scheduling.
However, the use of personal computers in this fashion is not required in following

3
the text material. Each instructor may exercise discretion in omitting some of the
material in these chapters if they are redundant with other classes or too advanced
for students in his or her own class.

It is our hope that students beginning their career in project management for
construction will be prepared to adopt the integrated approach emphasized in this
book. Furthermore, experienced professionals in various fields may discover in this
book some surprises that even they have not anticipated. High level decision
makers in owner organizations who are not directly involved in the project
management process may find the basic philosophy and principles of interest,
especially in Chapters 1 through 3, as owners must invariably pay for constructed
facilities, for better or worse. If the book can fulfill even a small part of its promises
to influence the future of project management for construction, our efforts will have
been amply rewarded.

For version 2.1 (Summer 2003), a number of new examples, updates and references
have been inserted throughout the text. For example, there are new discussions of
lean construction and green buildings. However, the basic structure and methods
remain the same. The fundamentals of project management treated here are
timeless.

Numerous individuals helped with the preparation of the first and second editions
of this book. In particular, we wish to acknowledge Burcu Akinci, William J. Hall,
Paul Christiano, Steven Fenves, Daniel Rehak, Debbie Scappatura, and Shirley
Knapp. Iavor Kostov, Tommy Hendrickson, Curt Yeske and In-Soo Jung were
instrumental in developing the web version of this book. This book also reflects the
contributions of numerous students and colleagues in industry who have challenged
us with problems and shared their own ideas and experience over many years. We
are grateful to all of these individuals.

Some material in this book has been taken from several papers authored by us and
published by the American Society of Civil Engineers. Materials taken from other
sources are acknowledged in footnotes, tables or figures. We gratefully
acknowledge the permissions given to us by these individuals, publishers and
organizations.

A series of photographs depicting various stages of construction of the PPG

building in Pittsburgh, PA is inserted in sequence between chapters. We wish to
thank PPG Industries for its cooperation in providing these photographs.

Chris Hendrickson and Tung Au

4
1. The Owners' Perspective
1.1 Introduction
Like the five blind men encountering different parts of an elephant, each of the
numerous participants in the process of planning, designing, financing, constructing
and operating physical facilities has a different perspective on project management
for construction. Specialized knowledge can be very beneficial, particularly in large
and complicated projects, since experts in various specialties can provide valuable
services. However, it is advantageous to understand how the different parts of the
process fit together. Waste, excessive cost and delays can result from poor
coordination and communication among specialists. It is particularly in the interest
of owners to insure that such problems do not occur. And it behooves all
participants in the process to heed the interests of owners because, in the end, it is
the owners who provide the resources and call the shots.

By adopting the viewpoint of the owners, we can focus our attention on the
complete process of project management for constructed facilities rather than the
historical roles of various specialists such as planners, architects, engineering
designers, constructors, fabricators, material suppliers, financial analysts and
others. To be sure, each specialty has made important advances in developing new
techniques and tools for efficient implementation of construction projects.
However, it is through the understanding of the entire process of project
management that these specialists can respond more effectively to the owner's
desires for their services, in marketing their specialties, and in improving the
productivity and quality of their work.

The introduction of innovative and more effective project management for

construction is not an academic exercise. As reported by the "Construction Industry
Cost Effectiveness Project" of the Business Roundtable: [1]

By common consensus and every available measure, the United States no longer
gets it's money's worth in construction, the nation's largest industry ... The creeping
erosion of construction efficiency and productivity is bad news for the entire U.S.
economy. Construction is a particularly seminal industry. The price of every
factory, office building, hotel or power plant that is built affects the price that must
be charged for the goods or services produced in it or by it. And that effect
generally persists for decades ... Too much of the industry remains tethered to the
past, partly by inertia and partly by historic divisions...

Improvement of project management not only can aid the construction industry, but
may also be the engine for the national and world economy. However, if we are to
make meaningful improvements, we must first understand the construction

5
industry, its operating environment and the institutional constraints affecting its
activities as well as the nature of project management.

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1.2 The Project Life Cycle

The acquisition of a constructed facility usually represents a major capital
investment, whether its owner happens to be an individual, a private corporation or
a public agency. Since the commitment of resources for such an investment is
motivated by market demands or perceived needs, the facility is expected to satisfy
certain objectives within the constraints specified by the owner and relevant
regulations. With the exception of the speculative housing market, where the
residential units may be sold as built by the real estate developer, most constructed
facilities are custom made in consultation with the owners. A real estate developer
may be regarded as the sponsor of building projects, as much as a government
agency may be the sponsor of a public project and turns it over to another
government unit upon its completion. From the viewpoint of project management,
the terms "owner" and "sponsor" are synonymous because both have the ultimate
authority to make all important decisions. Since an owner is essentially acquiring a
facility on a promise in some form of agreement, it will be wise for any owner to
have a clear understanding of the acquisition process in order to maintain firm
control of the quality, timeliness and cost of the completed facility.

From the perspective of an owner, the project life cycle for a constructed facility
may be illustrated schematically in Figure 1-1. Essentially, a project is conceived to
meet market demands or needs in a timely fashion. Various possibilities may be
considered in the conceptual planning stage, and the technological and economic
feasibility of each alternative will be assessed and compared in order to select the
best possible project. The financing schemes for the proposed alternatives must
also be examined, and the project will be programmed with respect to the timing
for its completion and for available cash flows. After the scope of the project is
clearly defined, detailed engineering design will provide the blueprint for
construction, and the definitive cost estimate will serve as the baseline for cost
control. In the procurement and construction stage, the delivery of materials and the
erection of the project on site must be carefully planned and controlled. After the
construction is completed, there is usually a brief period of start-up or shake-down
of the constructed facility when it is first occupied. Finally, the management of the
facility is turned over to the owner for full occupancy until the facility lives out its
useful life and is designated for demolition or conversion.

6
Figure 1-1: The Project Life Cycle of a Constructed Facility

Of course, the stages of development in Figure 1-1 may not be strictly sequential.
Some of the stages require iteration, and others may be carried out in parallel or
with overlapping time frames, depending on the nature, size and urgency of the
project. Furthermore, an owner may have in-house capacities to handle the work in
every stage of the entire process, or it may seek professional advice and services for

7
the work in all stages. Understandably, most owners choose to handle some of the
work in-house and to contract outside professional services for other components of
the work as needed. By examining the project life cycle from an owner's
perspective we can focus on the proper roles of various activities and participants in
all stages regardless of the contractual arrangements for different types of work.

In the United States, for example, the U.S. Army Corps of Engineers has in-house
capabilities to deal with planning, budgeting, design, construction and operation of
waterway and flood control structures. Other public agencies, such as state
transportation departments, are also deeply involved in all phases of a construction
project. In the private sector, many large firms such as DuPont, Exxon, and IBM
are adequately staffed to carry out most activities for plant expansion. All these
owners, both public and private, use outside agents to a greater or lesser degree
when it becomes more advantageous to do so.

The project life cycle may be viewed as a process through which a project is
implemented from cradle to grave. This process is often very complex; however, it
can be decomposed into several stages as indicated by the general outline in Figure
1-1. The solutions at various stages are then integrated to obtain the final outcome.
Although each stage requires different expertise, it usually includes both technical
and managerial activities in theknowledge domain of the specialist. The owner may
choose to decompose the entire process into more or less stages based on the size
and nature of the project, and thus obtain the most efficient result in
implementation. Very often, the owner retains direct control of work in the
planning and programming stages, but increasingly outside planners and financial
experts are used as consultants because of the complexities of projects. Since
operation and maintenance of a facility will go on long after the completion and
acceptance of a project, it is usually treated as a separate problem except in the
consideration of the life cycle cost of a facility. All stages from conceptual planning
and feasibility studies to the acceptance of a facility for occupancy may be broadly
lumped together and referred to as the Design/Construct process, while the
procurement and construction alone are traditionally regarded as the province of the
construction industry.

Owners must recognize that there is no single best approach in organizing project
management throughout a project's life cycle. All organizational approaches have
advantages and disadvantages, depending on the knowledge of the owner in
construction management as well as the type, size and location of the project. It is
important for the owner to be aware of the approach which is most appropriate and
beneficial for a particular project. In making choices, owners should be concerned
with the life cycle costs of constructed facilities rather than simply the initial
construction costs. Saving small amounts of money during construction may not be
worthwhile if the result is much larger operating costs or not meeting the functional
requirements for the new facility satisfactorily. Thus, owners must be very
concerned with the quality of the finished product as well as the cost of

8
construction itself. Since facility operation and maintenance is a part of the project
life cycle, the owners' expectation to satisfy investment objectives during the
project life cycle will require consideration of the cost of operation and
maintenance. Therefore, the facility's operating management should also be
considered as early as possible, just as the construction process should be kept in
mind at the early stages of planning and programming.

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1.3 Major Types of Construction

Since most owners are generally interested in acquiring only a specific type of
constructed facility, they should be aware of the common industrial practices for
the type of construction pertinent to them. Likewise, theconstruction industry is a
conglomeration of quite diverse segments and products. Some owners may procure
a constructed facility only once in a long while and tend to look for short term
advantages. However, many owners require periodic acquisition of new facilities
and/or rehabilitation of existing facilities. It is to their advantage to keep the
construction industry healthy and productive. Collectively, the owners have more
power to influence the construction industry than they realize because, by their
individual actions, they can provide incentives or disincentives for innovation,
efficiency and quality in construction. It is to the interest of all parties that the
owners take an active interest in the construction and exercise beneficial influence
on the performance of the industry.

In planning for various types of construction, the methods of procuring professional

services, awarding construction contracts, and financing the constructed facility can
be quite different. For the purpose of discussion, the broad spectrum of constructed
facilities may be classified into four major categories, each with its own
characteristics.

Residential Housing Construction

Residential housing construction includes single-family houses, multi-family

dwellings, and high-rise apartments. During the development and construction of
such projects, the developers or sponsors who are familiar with the construction
industry usually serve as surrogate owners and take charge, making necessary
contractual agreements for design and construction, and arranging the financing
and sale of the completed structures. Residential housing designs are usually
performed by architects and engineers, and the construction executed by builders
who hire subcontractors for the structural, mechanical, electrical and other specialty
work. An exception to this pattern is for single-family houses which may be
designed by the builders as well.

9
The residential housing market is heavily affected by general economic conditions,
tax laws, and the monetary and fiscal policies of the government. Often, a slight
increase in total demand will cause a substantial investment in construction, since
many housing projects can be started at different locations by different individuals
and developers at the same time. Because of the relative ease of entry, at least at the
lower end of the market, many new builders are attracted to the residential housing
construction. Hence, this market is highly competitive, with potentially high risks
as well as high rewards.

Figure 1-2: Residential Housing Construction (courtesy of Caterpillar, Inc.)

Institutional and Commercial Building Construction

Institutional and commercial building construction encompasses a great variety of

project types and sizes, such as schools and universities, medical clinics and
hospitals, recreational facilities and sports stadiums, retail chain stores and large
shopping centers, warehouses and light manufacturing plants, and skyscrapers for
offices and hotels. The owners of such buildings may or may not be familiar with
construction industry practices, but they usually are able to select competent
professional consultants and arrange the financing of the constructed facilities
themselves. Specialty architects and engineers are often engaged for designing a
specific type of building, while the builders or general contractors undertaking such
projects may also be specialized in only that type of building.

Because of the higher costs and greater sophistication of institutional and

commercial buildings in comparison with residential housing, this market segment
is shared by fewer competitors. Since the construction of some of these buildings is
a long process which once started will take some time to proceed until completion,
the demand is less sensitive to general economic conditions than that for
speculative housing. Consequently, the owners may confront an oligopoly of
general contractors who compete in the same market. In an oligopoly situation,
only a limited number of competitors exist, and a firm's price for services may be
based in part on its competitive strategies in the local market.

10
Figure 1-3: Construction of the PPG Building in Pittsburgh, Pennsylvania
(courtesy of PPG Industries, Inc.)

Specialized Industrial Construction

Specialized industrial construction usually involves very large scale projects with a
high degree of technological complexity, such as oil refineries, steel mills, chemical
processing plants and coal-fired or nuclear power plants. The owners usually are
deeply involved in the development of a project, and prefer to work with designers-
builders such that the total time for the completion of the project can be shortened.
They also want to pick a team of designers and builders with whom the owner has
developed good working relations over the years.

Although the initiation of such projects is also affected by the state of the economy,
long range demand forecasting is the most important factor since such projects are
capital intensive and require considerable amount of planning and construction
time. Governmental regulation such as the rulings of the Environmental Protection
Agency and the Nuclear Regulatory Commission in the United States can also
profoundly influence decisions on these projects.

11
Figure 1-4: Construction of a Benzene Plant in Lima, Ohio (courtesy of
Manitowoc Company, Inc.)

Infrastructure and Heavy Construction

Infrastructure and heavy construction includes projects such as highways, mass

transit systems, tunnels, bridges, pipelines, drainage systems and sewage treatment
plants. Most of these projects are publicly owned and therefore financed either
through bonds or taxes. This category of construction is characterized by a high
degree of mechanization, which has gradually replaced some labor intensive
operations.

The engineers and builders engaged in infrastructure construction are usually

highly specialized since each segment of the market requires different types of
skills. However, demands for different segments of infrastructure and heavy
construction may shift with saturation in some segments. For example, as the
available highway construction projects are declining, some heavy construction
contractors quickly move their work force and equipment into the field of mining
where jobs are available.

12
Figure 1-5: Construction of the Dame Point Bridge in Jacksonville, Florida
(courtesy of Mary Lou Maher)

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1.4 Selection of Professional Services

When an owner decides to seek professional services for the design and
construction of a facility, he is confronted with a broad variety of choices. The type
of services selected depends to a large degree on the type of construction and the
experience of the owner in dealing with various professionals in the previous
projects undertaken by the firm. Generally, several common types of professional
services may be engaged either separately or in some combination by the owners.

Financial Planning Consultants

At the early stage of strategic planning for a capital project, an owner often seeks
the services of financial planning consultants such as certified public accounting
(CPA) firms to evaluate the economic and financial feasibility of the constructed
facility, particularly with respect to various provisions of federal, state and local tax
laws which may affect the investment decision. Investment banks may also be
consulted on various options for financing the facility in order to analyze their
long-term effects on the financial health of the owner organization.

Architectural and Engineering Firms

Traditionally, the owner engages an architectural and engineering (A/E) firm or

consortium as technical consultant in developing a preliminary design. After the
engineering design and financing arrangements for the project are completed, the
owner will enter into a construction contract with a general contractor either
through competitive bidding or negotiation. The general contractor will act as a
constructor and/or a coordinator of a large number of subcontractors who perform
various specialties for the completion of the project. The A/E firm completes the
design and may also provide on site quality inspection during construction. Thus,

13
the A/E firm acts as the prime professional on behalf of the owner and supervises
the construction to insure satisfactory results. This practice is most common in
building construction.

In the past two decades, this traditional approach has become less popular for a
number of reasons, particularly for large scale projects. The A/E firms, which are
engaged by the owner as the prime professionals for design and inspection, have
become more isolated from the construction process. This has occurred because of
pressures to reduce fees to A/E firms, the threat of litigation regarding construction
defects, and lack of knowledge of new construction techniques on the part of
architect and engineering professionals. Instead of preparing a construction plan
along with the design, many A/E firms are no longer responsible for the details of
construction nor do they provide periodic field inspection in many cases. As a
matter of fact, such firms will place a prominent disclaimer of responsibilities on
any shop drawings they may check, and they will often regard their representatives
in the field as observers instead of inspectors. Thus, the A/E firm and the general
contractor on a project often become antagonists who are looking after their own
competing interests. As a result, even the constructibility of some engineering
designs may become an issue of contention. To carry this protective attitude to the
extreme, the specifications prepared by an A/E firm for the general contractor often
protects the interest of the A/E firm at the expense of the interests of the owner and
the contractor.

In order to reduce the cost of construction, some owners introduce value

engineering, which seeks to reduce the cost of construction by soliciting a second
design that might cost less than the original design produced by the A/E firm. In
practice, the second design is submitted by the contractor after receiving a
construction contract at a stipulated sum, and the saving in cost resulting from the
redesign is shared by the contractor and the owner. The contractor is able to absorb
the cost of redesign from the profit in construction or to reduce the construction
cost as a result of the re-design. If the owner had been willing to pay a higher fee to
the A/E firm or to better direct the design process, the A/E firm might have
produced an improved design which would cost less in the first place. Regardless
of the merit of value engineering, this practice has undermined the role of the A/E
firm as the prime professional acting on behalf of the owner to supervise the
contractor.

Design/Construct Firms

A common trend in industrial construction, particularly for large projects, is to

engage the services of a design/construct firm. By integrating design and
construction management in a single organization, many of the conflicts between
designers and constructors might be avoided. In particular, designs will be closely
scrutinized for their constructibility. However, an owner engaging a
design/construct firm must insure that the quality of the constructed facility is not

14
sacrificed by the desire to reduce the time or the cost for completing the project.
Also, it is difficult to make use of competitive bidding in this type of
design/construct process. As a result, owners must be relatively sophisticated in
negotiating realistic and cost-effective construction contracts.

One of the most obvious advantages of the integrated design/construct process is

the use of phased construction for a large project. In this process, the project is
divided up into several phases, each of which can be designed and constructed in a
staggered manner. After the completion of the design of the first phase,
construction can begin without waiting for the completion of the design of the
second phase, etc. If proper coordination is exercised. the total project duration can
be greatly reduced. Another advantage is to exploit the possibility of using
the turnkey approach whereby an owner can delegate all responsibility to the
design/construct firm which will deliver to the owner a completed facility that
meets the performance specifications at the specified price.

Professional Construction Managers

In recent years, a new breed of construction managers (CM) offers professional

services from the inception to the completion of a construction project. These
construction managers mostly come from the ranks of A/E firms or general
contractors who may or may not retain dual roles in the service of the owners. In
any case, the owner can rely on the service of a single prime professional to
manage the entire process of a construction project. However, like the A/E firms of
several decades ago, the construction managers are appreciated by some owners but
not by others. Before long, some owners find that the construction managers too
may try to protect their own interest instead of that of the owners when the stakes
are high.

It should be obvious to all involved in the construction process that the party which
is required to take higher risk demands larger rewards. If an owner wants to engage
an A/E firm on the basis of low fees instead of established qualifications, it often
gets what it deserves; or if the owner wants the general contractor to bear the cost
of uncertainties in construction such as foundation conditions, the contract price
will be higher even if competitive bidding is used in reaching a contractual
agreement. Without mutual respect and trust, an owner cannot expect that
construction managers can produce better results than other professionals. Hence,
an owner must understand its own responsibility and the risk it wishes to assign to
itself and to other participants in the process.

Operation and Maintenance Managers

Although many owners keep a permanent staff for the operation and maintenance
of constructed facilities, others may prefer to contract such tasks to professional
managers. Understandably, it is common to find in-house staff for operation and

15
maintenance in specialized industrial plants and infrastructure facilities, and the use
of outside managers under contracts for the operation and maintenance of rental
properties such as apartments and office buildings. However, there are exceptions
to these common practices. For example, maintenance of public roadways can be
contracted to private firms. In any case, managers can provide a spectrum of
operation and maintenance services for a specified time period in accordance to the
terms of contractual agreements. Thus, the owners can be spared the provision of
in-house expertise to operate and maintain the facilities.

Facilities Management

As a logical extension for obtaining the best services throughout the project life
cycle of a constructed facility, some owners and developers are receptive to adding
strategic planning at the beginning and facility maintenance as a follow-up to
reduce space-related costs in their real estate holdings. Consequently, some
architectural/engineering firms and construction management firms with computer-
based expertise, together with interior design firms, are offering such front-end and
follow-up services in addition to the more traditional services in design and
construction. This spectrum of services is described in Engineering News-
Record (now ENR) as follows: [2]

Facilities management is the discipline of planning, designing, constructing and

managing space -- in every type of structure from office buildings to process plants.
It involves developing corporate facilities policy, long-range forecasts, real estate,
space inventories, projects (through design, construction and renovation), building
operation and maintenance plans and furniture and equipment inventories.

A common denominator of all firms entering into these new services is that they all
have strong computer capabilities and heavy computer investments. In addition to
the use of computers for aiding design and monitoring construction, the service
includes the compilation of a computer record of building plans that can be turned
over at the end of construction to the facilities management group of the owner. A
computer data base of facilities information makes it possible for planners in the
owner's organization to obtain overview information for long range space forecasts,
while the line managers can use as-built information such as lease/tenant records,
utility costs, etc. for day-to-day operations.

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1.5 Construction Contractors

Builders who supervise the execution of construction projects are traditionally
referred to as contractors, or more appropriately called constructors. The general
contractor coordinates various tasks for a project while the specialty
contractors such as mechanical or electrical contractors perform the work in their

16
specialties. Material and equipment suppliers often act as installation contractors;
they play a significant role in a construction project since the conditions of delivery
of materials and equipment affect the quality, cost, and timely completion of the
project. It is essential to understand the operation of these contractors in order to
deal with them effectively.

General Contractors

The function of a general contractor is to coordinate all tasks in a construction

project. Unless the owner performs this function or engages a professional
construction manager to do so, a good general contractor who has worked with a
team of superintendents, specialty contractors or subcontractors together for a
number of projects in the past can be most effective in inspiring loyalty and
cooperation. The general contractor is also knowledgeable about the labor force
employed in construction. The labor force may or may not be unionized depending
on the size and location of the projects. In some projects, no member of the work
force belongs to a labor union; in other cases, both union and non-union craftsmen
work together in what is called an open shop, or all craftsmen must be affiliated
with labor unions in a closed shop. Since labor unions provide hiring halls staffed
with skilled journeyman who have gone through apprentice programs for the
projects as well as serving as collective bargain units, an experienced general
contractor will make good use of the benefits and avoid the pitfalls in dealing with
organized labor.

Specialty Contractors

Specialty contractors include mechanical, electrical, foundation, excavation, and

demolition contractors among others. They usually serve as subcontractors to the
general contractor of a project. In some cases, legal statutes may require an owner
to deal with various specialty contractors directly. In the State of New York, for
example, specialty contractors, such as mechanical and electrical contractors, are
not subjected to the supervision of the general contractor of a construction project
and must be given separate prime contracts on public works. With the exception of
such special cases, an owner will hold the general contractor responsible for
negotiating and fulfilling the contractual agreements with the subcontractors.

Material and Equipment Suppliers

Major material suppliers include specialty contractors in structural steel fabrication

and erection, sheet metal, ready mixed concrete delivery, reinforcing steel bar
detailers, roofing, glazing etc. Major equipment suppliers for industrial
construction include manufacturers of generators, boilers and piping and other
equipment. Many suppliers handle on-site installation to insure that the
requirements and contractual specifications are met. As more and larger structural

17
units are prefabricated off-site, the distribution between specialty contractors and
material suppliers becomes even less obvious.

Back to top

1.6 Financing of Constructed Facilities

A major construction project requires an enormous amount of capital that is often
supplied by lenders who want to be assured that the project will offer a fair return
on the investment. The direct costs associated with a major construction project
may be broadly classified into two categories: (1) the construction expenses paid to
the general contractor for erecting the facility on site and (2) the expenses for land
acquisition, legal fees, architect/engineer fees, construction management fees,
interest on construction loans and the opportunity cost of carrying empty space in
the facility until it is fully occupied. The direct construction costs in the first
category represent approximately 60 to 80 percent of the total costs in most
construction projects. Since the costs of construction are ultimately borne by the
owner, careful financial planning for the facility must be made prior to
construction.

Construction Financing

Construction loans to contractors are usually provided by banks or savings and loan
associations for construction financing. Upon the completion of the facility,
construction loans will be terminated and the post-construction facility financing
will be arranged by the owner.

Construction loans provided for different types of construction vary. In the case of
residential housing, construction loans and long-term mortgages can be obtained
from savings and loans associations or commercial banks. For institutional and
commercial buildings, construction loans are usually obtained from commercial
banks. Since the value of specialized industrial buildings as collateral for loans is
limited, construction loans in this domain are rare, and construction financing can
be done from the pool of general corporate funds. For infrastructure construction
owned by government, the property cannot be used as security for a private loan,
but there are many possible ways to finance the construction, such as general
appropriation from taxation or special bonds issued for the project.

Traditionally, banks serve as construction lenders in a three-party agreement among

the contractor, the owner and the bank. The stipulated loan will be paid to the
contractor on an agreed schedule upon the verification of completion of various
portions of the project. Generally, a payment request together with a standard
progress report will be submitted each month by the contractor to the owner which
in turn submits a draw request to the bank. Provided that the work to date has been
performed satisfactorily, the disbursement is made on that basis during the

18
construction period. Under such circumstances, the bank has been primarily
concerned with the completion of the facility on time and within the budget. The
economic life of the facility after its completion is not a concern because of the
transfer of risk to the owner or an institutional lender.

Facility Financing

Many private corporations maintain a pool of general funds resulting from retained
earnings and long-term borrowing on the strength of corporate assets, which can be
used for facility financing. Similarly, for public agencies, the long-term funding
may be obtained from the commitment of general tax revenues from the federal,
state and/or local governments. Both private corporations and public agencies may
issue special bonds for the constructed facilities which may obtain lower interest
rates than other forms of borrowing. Short-term borrowing may also be used for
bridging the gaps in long-term financing. Some corporate bonds are convertible to
stocks under circumstances specified in the bond agreement. For public facilities,
the assessment of user fees to repay the bond funds merits consideration for certain
types of facilities such as toll roads and sewage treatment plants. [3] The use of
mortgages is primarily confined to rental properties such as apartments and office
buildings.

Because of the sudden surge of interest rates in the late 1970's, many financial
institutions offer, in addition to the traditional fixed rate long-term mortgage
commitments, other arrangements such as a combination of debt and a percentage
of ownership in exchange for a long-term mortgage or the use of adjustable rate
mortgages. In some cases, the construction loan may be granted on an open-ended
basis without a long-term financing commitment. For example, the plan might be
issued for the construction period with an option to extend it for a period of up to
three years in order to give the owner more time to seek alternative long-term
financing on the completed facility. The bank will be drawn into situations
involving financial risk if it chooses to be a lender without long-term guarantees.

For international projects, the currency used for financing agreements becomes
important. If financial agreements are written in terms of local currencies, then
fluctuations in the currency exchange rate can significantly affect the cost and
ultimately profit of a project. In some cases, payments might also be made in
particular commodities such as petroleum or the output from the facility itself.
Again, these arrangements result in greater uncertainty in the financing scheme
because the price of these commodities may vary.

Back to top

1.7 Legal and Regulatory Requirements

19
The owners of facilities naturally want legal protection for all the activities
involved in the construction. It is equally obvious that they should seek competent
legal advice. However, there are certain principles that should be recognized by
owners in order to avoid unnecessary pitfalls.

Legal Responsibilities

Activities in construction often involve risks, both physical and financial. An owner
generally tries to shift the risks to other parties to the degree possible when entering
into contractual agreements with them. However, such action is not without cost or
risk. For example, a contractor who is assigned the risks may either ask for a higher
contract price to compensate for the higher risks, or end up in non-performance or
bankruptcy as an act of desperation. Such consequences can be avoided if the
owner is reasonable in risk allocation. When risks are allocated to different parties,
the owner must understand the implications and spell them out clearly. Sometimes
there are statutory limitations on the allocation of liabilities among various groups,
such as prohibition against the allocation of negligence in design to the contractor.
An owner must realize its superior power in bargaining and hence the
responsibilities associated with this power in making contractual agreements.

Mitigation of Conflicts

It is important for the owner to use legal counselors as advisors to mitigate conflicts
before they happen rather than to wield conflicts as weapons against other parties.
There are enough problems in design and construction due to uncertainty rather
than bad intentions. The owner should recognize the more enlightened approaches
for mitigating conflicts, such as using owner-controlled wrap-up insurance which
will provide protection for all parties involved in the construction process for
unforeseen risks, or using arbitration, mediation and other extra-judicial solutions
for disputes among various parties. However, these compromise solutions are not
without pitfalls and should be adopted only on the merit of individual cases.

Government Regulation

To protect public safety and welfare, legislatures and various government agencies
periodically issue regulations which influence the construction process, the
operation of constructed facilities, and their ultimate disposal. For example,
building codes promulgated by local authorities have provided guidelines for
design and construction practices for a very long time. Since the 1970's, many
federal regulations that are related directly or indirectly to construction have been
established in the United States. Among them are safety standards for workers
issued by the Occupational Health and Safety Administration, environmental
standards on pollutants and toxic wastes issued by the Environmental Protection
Agency, and design and operation procedures for nuclear power plants issued by
the Nuclear Regulatory Commission.

20
Owners must be aware of the impacts of these regulations on the costs and
durations of various types of construction projects as well as possibilities of
litigation due to various contentions. For example, owners acquiring sites for new
construction may be strictly liable for any hazardous wastes already on the site or
removed from the site under the U.S. Comprehensive Environmental Response
Compensation and Liability (CERCL) Act of 1980. For large scale projects
involving new technologies, the construction costs often escalate with the
uncertainty associated with such restrictions.

Back to top

1.8 The Changing Environment of the Construction

Industry
The construction industry is a conglomeration of diverse fields and participants that
have been loosely lumped together as a sector of the economy. The construction
industry plays a central role in national welfare, including the development of
residential housing, office buildings and industrial plants, and the restoration of the
nation's infrastructure and other public facilities. The importance of the
construction industry lies in the function of its products which provide the
foundation for industrial production, and its impacts on the national economy
cannot be measured by the value of its output or the number of persons employed
in its activities alone.

To be more specific, construction refers to all types of activities usually associated

with the erection and repair of immobile facilities. Contract construction consists of
a large number of firms that perform construction work for others, and is estimated
to be approximately 85% of all construction activities. The remaining 15% of
construction is performed by owners of the facilities, and is referred to as force-
account construction. Although the number of contractors in the United States
exceeds a million, over 60% of all contractor construction is performed by the top
400 contractors. The value of new construction in the United States (expressed in
constant dollars) and the value of construction as a percentage of the gross national
products from 1950 to 1985 are shown in Figures 1-6 and 1-7. It can be seen that
construction is a significant factor in the Gross National Productalthough its
importance has been declining in recent years. [4] Not to be ignored is the fact that
as the nation's constructed facilities become older, the total expenditure on
rehabilitation and maintenance may increase relative to the value of new
construction.

21
Figure 1-6: Value of New Construction in the United States, 1975-1995

Figure 1-7: Construction as Percentage of Gross Domestic Product in the United

States, 1975-1995

Owners who pay close attention to the peculiar characteristics of the construction
industry and its changing operating environment will be able to take advantage of
the favorable conditions and to avoid the pitfalls. Several factors are particularly
noteworthy because of their significant impacts on the quality, cost and time of
construction.

22
New Technologies

In recent years, technological innovation in design, materials and construction

methods have resulted in significant changes in construction costs. Computer-aids
have improved capabilities for generating quality designs as well as reducing the
time required to produce alternative designs. New materials not only have enhanced
the quality of construction but also have shortened the time for shop fabrication and
field erection. Construction methods have gone through various stages of
mechanization and automation, including the latest development of construction
robotics.

The most dramatic new technology applied to construction has been the Internet
and its private, corporate Intranet versions. The Internet is widely used as a means
to foster collaboration among professionals on a project, to communicate for bids
and results, and to procure necessary goods and services. Real time video from
specific construction sites is widely used to illustrate construction progress to
interested parties. The result has been more effective collaboration, communication
and procurement.

The effects of many new technologies on construction costs have been mixed
because of the high development costs for new technologies. However, it is
unmistakable that design professionals and construction contractors who have not
adapted to changing technologies have been forced out of the mainstream of design
and construction activities. Ultimately, construction quality and cost can be
improved with the adoption of new technologies which are proved to be efficient
from both the viewpoints of performance and economy.

Labor Productivity

The term productivity is generally defined as a ratio of the production output

volume to the input volume of resources. Since both output and input can be
quantified in a number of ways, there is no single measure of productivity that is
universally applicable, particularly in the construction industry where the products
are often unique and there is no standard for specifying the levels for aggregation of
data. However, since labor constitutes a large part of the cost of construction, labor
productivity in terms of output volume (constant dollar value or functional units)
per person-hour is a useful measure. Labor productivity measured in this way does
not necessarily indicate the efficiency of labor alone but rather measures the
combined effects of labor, equipment and other factors contributing to the output.

While aggregate construction industry productivity is important as a measure of

national economy, owners are more concerned about the labor productivity of basic
units of work produced by various crafts on site. Thus, an owner can compare the
labor performance at different geographic locations, under different working
conditions, and for different types and sizes of projects.

23
Construction costs usually run parallel to material prices and labor wages. Actually,
over the years, labor productivity has increased in some traditional types of
construction and thus provides a leveling or compensating effect when hourly rates
for labor increase faster than other costs in construction. However, labor
productivity has been stagnant or even declined in unconventional or large scale
projects.

Public Scrutiny

Under the present litigious climate in the United States, the public is increasingly
vocal in the scrutiny of construction project activities. Sometimes it may result in
considerable difficulty in siting new facilities as well as additional expenses during
the construction process itself. Owners must be prepared to manage such crises
before they get out of control.

Figure 1-8 can serve to indicate public attitudes towards the siting of new facilities.
It represents the cumulative percentage of individuals who would be willing to
accept a new industrial facility at various distances from their homes. For example,
over fifty percent of the people surveyed would accept a ten-story office building
within five miles of their home, but only twenty-five percent would accept a large
factory or coal fired power plant at a similar distance. An even lower percentage
would accept a hazardous waste disposal site or a nuclear power plant. Even at a
distance of one hundred miles, a significant fraction of the public would be
unwilling to accept hazardous waste facilities or nuclear power plants.

24
Figure 1-8: Public Acceptance Towards New Facilities (Reprinted
from Environmental Quality - 1980,
the Eleventh Annual Report of the Council on Environmental Quality, U.S.
Government Printing Office, Washington, DC, December 1980.)

This objection to new facilities is a widespread public attitude, representing

considerable skepticism about the external benefits and costs which new facilities
will impose. It is this public attitude which is likely to make public scrutiny and
regulation a continuing concern for the construction industry.

International Competition

25
A final trend which deserves note is the increasing level of international
competition in the construction industry. Owners are likely to find non-traditional
firms bidding for construction work, particularly on large projects. Separate bids
from numerous European, North American, and Asian construction firms are not
unusual. In the United States, overseas firms are becoming increasingly visible and
important. In this environment of heightened competition, good project
management and improved productivity are more and more important.

A bidding competition for a major new offshore drilling platform illustrates the
competitive environment in construction. As described in the Wall Street
Journal: [5]

Through most of the postwar years, the nation's biggest builders of offshore oil
platforms enjoyed an unusually cozy relationship with the Big Oil Companies they
served. Their top officials developed personal friendships with oil executives,
entertained them at opulent hunting camps- and won contracts to build nearly every
major offshore oil platform in the world....But this summer, the good-old boy
network fell apart. Shell [Oil Co.] awarded the main contract for [a new] platform -
taller than Chicago's Sears Tower, four times heavier than the Brooklyn Bridge - to
a tiny upstart.

The winning bidder arranged overseas fabrication of the rig, kept overhead costs
low, and proposed a novel assembly procedure by which construction equipment
was mounted on completed sections of the platform in order to speed the
completion of the entire structure. The result was lower costs than those estimated
and bid by traditional firms.

Of course, U.S. firms including A/E firms, contractors and construction managers
are also competing in foreign countries. Their success or failure in the international
arena may also affect their capacities and vitality to provide services in the
domestic U.S. market.

Contractor Financed Projects

Increasingly, some owners look to contractors or joint ventures as a resource to

design, to build and to finance a constructed facility. For example, a utility
company may seek a consortium consisting of a design/construct firm and a
financial investment firm to assume total liability during construction and thereby
eliminate the risks of cost escalation to ratepayers, stockholders and the
management. On the other hand, a local sanitation district may seek such a
consortium to provide private ownership for a proposed new sewage treatment
plant. In the former case, the owner may take over the completed facility and
service the debt on construction through long-term financing arrangements; in the
latter case, the private owner may operate the completed facility and recover its
investment through user fees. The activities of joint ventures among design,

26
construction and investment firms are sometimes referred to as financial
engineering.

This type of joint venture has become more important in the international
construction market where aggressive contractors often win contracts by offering a
more attractive financing package rather than superior technology. With a
deepening shadow of international debts in recent years, many developing countries
are not in a position to undertake any new project without contractor-backed
financing. Thus, the contractors or joint ventures in overseas projects are forced
into very risky positions if they intend to stay in the competition.

Lean Construction

"Lean manufacturing" had a revolutionary effect on many industries, especially

automotive assembly companies. Characteristics of this approach include:

• Improvement in quality and reduction of waste everywhere. Rather than

increasing costs, reducing defects and waste proved to improve quality and
reduce costs.
• Empowering workers to be responsible for satisfying customer needs. In
construction, for example, craftsman should make sure their work satisfied
the design intent.
• Continuous improvement of processes involving the entire workforce.

Lean construction is intended to spread these practices within the construction

industry. Of course, well managed construction projects already have many aspects
of lean construction. For example, just-in-time delivery of materials is
commonplace to avoid the waste of large inventory stockpiles. Green building
projects attempt to re-use or recycle all construction wastes. But the systematic
attention to continuous improvement and zero accidents and defects is new. Back to
top

1.9 The Role of Project Managers

In the project life cycle, the most influential factors affecting the outcome of the
project often reside at the early stages. At this point, decisions should be based on
competent economic evaluation with due consideration for adequate financing, the
prevalent social and regulatory environment, and technological considerations.
Architects and engineers might specialize in planning, in construction field
management, or in operation, but as project managers, they must have some
familiarity with all such aspects in order to understand properly their role and be
able to make competent decisions.

Since the 1970's, many large-scale projects have run into serious problems of
management, such as cost overruns and long schedule delays. Actually, the

27
management of megaprojects or superprojects is not a practice peculiar to our time.
Witness the construction of transcontinental railroads in the Civil War era and the
construction of the Panama Canal at the turn of this century. Although the
megaprojects of this generation may appear in greater frequency and present a new
set of challenge, the problems are organizational rather than technical. As noted by
Hardy Cross: [6]

It is customary to think of engineering as a part of a trilogy, pure science, applied

science and engineering. It needs emphasis that this trilogy is only one of a triad of
trilogies into which engineering fits. This first is pure science, applied science and
engineering; the second is economic theory, finance and engineering; and the third
is social relations, industrial relations and engineering. Many engineering problems
are as closely allied to social problems as they are to pure science.

As engineers advance professionally, they often spend as much or more time on

planning, management and other economic or social problems as on the traditional
engineering design and analysis problems which form the core of most educational
programs. It is upon the ability of engineers to tackle all such problems that their
performance will ultimately be judged.

The greatest stumbling block to effective management in construction is the inertia

and historic divisions among planners, designers and constructors. While technical
competence in design and innovation remains the foundation of engineering
practice, the social, economic and organizational factors that are pervasive in
influencing the success and failure of construction projects must also be dealt with
effectively by design and construction organizations. Of course, engineers are not
expected to know every detail of management techniques, but they must be
knowledgeable enough to anticipate the problems of management so that they can
work harmoniously with professionals in related fields to overcome the inertia and
historic divisions.

Paradoxically, engineers who are creative in engineering design are often

innovative in planning and management since both types of activities involve
problem solving. In fact, they can reinforce each other if both are included in the
education process, provided that creativity and innovation instead of routine
practice are emphasized. A project manager who is well educated in
the fundamental principles of engineering design and management can usefully
apply such principles once he or she has acquired basic understanding of a
new application area. A project manager who has been trained by rote learning for
a specific type of project may merely gain one year of experience repeated twenty
times even if he or she has been in the field for twenty years. A broadly educated
project manager can reasonably hope to become a leader in the profession; a
narrowly trained project manager is often relegated to the role of his or her first job
level permanently.

28
The owners have much at stake in selecting a competent project manager and in
providing her or him with the authority to assume responsibility at various stages of
the project regardless of the types of contractual agreements for implementing the
project. Of course, the project manager must also possess the leadership quality and
the ability to handle effectively intricate interpersonal relationships within an
organization. The ultimate test of the education and experience of a project
manager for construction lies in her or his ability to apply fundamental principles to
solving problems in the new and unfamiliar situations which have become the
hallmarks of the changing environment in the construction industry.

Back to top

1.10 References
1. Au, T. and C. Hendrickson, "Education in Engineering Planning and
Management," Proceedings of the ASCE Conference on Civil Engineering
Education, Columbus, Ohio, 1985.
2. Barrie, D.S. (editor), Directions in Managing Construction, John Wiley and
Sons, New York, 1981.
3. Lean Construction Institute, http://www.leanconstruction.org/
4. Bonny, J.B. and J.P. Frein, Handbook of Construction Management and
Organization, 2nd Edition, Van Nostrand Reinhold Co., New York, 1980.
5. Hasagawa, Fumio et.al., "Built by Japan," John Wiley & Sons, 1988.
6. Lang, J.E. and D.Q. Mills, The Construction Industry, Lexington Books,
Lexington, MA, 1979.
7. Walker, N., E.N. Walker and T.K. Rohdenburg, Legal Pitfalls in
Architecture, Engineering and Building Construction, 2nd Edition,
McGraw-Hill Book Co., New York, 1979.

Back to top

1.11 Footnotes
1. The Business Roundtable, More Construction for the Money, Summary
Report of the Construction Industry Cost Effectiveness Project, January
1983, p. 11. Back
2. "Hot New Market Lures A-E Players to Cutting Edges," Engineering News-
Record, April 4, 1985, pp. 30-37. Back
3. See Hendrickson, C., "Financing Civil Works with User Fees," Civil
Engineering, Vol. 53, No. 2, February 1983, pp. 71-72. Back
4. The graph is derived from data in "Value of New Construction Put in Place,
1960-1983", Statistical Abstract of the United States, 105th Edition, U.S.
Department of Commerce, Bureau of Census, 1985, pp. 722-723, as well as
the information in earlier editions. Back

29
5. See Petzinger, Thomas Jr., "Upstart's Winning Bid for Offshore Platform
Stuns its Older Rivals," Wall Street Journal, p. 1, c. 6, Nov. 20, 1985. Back
6. See H. Cross, Engineers and Ivory Towers, McGraw-Hill Book Co., Inc.,
New York, 1952. Back

30
2. Organizing for Project Management
2.1 What is Project Management?
The management of construction projects requires knowledge of modern
management as well as an understanding of the design and construction process.
Construction projects have a specific set of objectives and constraints such as a
required time frame for completion. While the relevant technology, institutional
arrangements or processes will differ, the management of such projects has much in
common with the management of similar types of projects in other specialty or
technology domains such as aerospace, pharmaceutical and energy developments.

Generally, project management is distinguished from the general management of

corporations by the mission-oriented nature of a project. A project organization will
generally be terminated when the mission is accomplished. According to the
Project Management Institute, the discipline of project management can be defined
as follows: [1]

Project management is the art of directing and coordinating human and material
resources throughout the life of a project by using modern management techniques
to achieve predetermined objectives of scope, cost, time, quality and participation
satisfaction.

By contrast, the general management of business and industrial corporations

assumes a broader outlook with greater continuity of operations. Nevertheless,
there are sufficient similarities as well as differences between the two so that
modern management techniques developed for general management may be
adapted for project management.

The basic ingredients for a project management framework [2] may be represented
schematically in Figure 2-1. A working knowledge of general management and
familiarity with the special knowledge domain related to the project are
indispensable. Supporting disciplines such as computer science and decision
science may also play an important role. In fact, modern management practices and
various special knowledge domains have absorbed various techniques or tools
which were once identified only with the supporting disciplines. For example,
computer-based information systems and decision support systems are now
common-place tools for general management. Similarly, many operations research
techniques such as linear programming and network analysis are now widely used
in many knowledge or application domains. Hence, the representation in Figure 2-1
reflects only the sources from which the project management framework evolves.

31
Figure 2-1: Basic Ingredients in Project Management

Specifically, project management in construction encompasses a set of objectives

which may be accomplished by implementing a series of operations subject to
resource constraints. There are potential conflicts between the stated objectives
with regard to scope, cost, time and quality, and the constraints imposed on human
material and financial resources. These conflicts should be resolved at the onset of
a project by making the necessary tradeoffs or creating new alternatives.
Subsequently, the functions of project management for construction generally
include the following:

1. Specification of project objectives and plans including delineation of scope,

budgeting, scheduling, setting performance requirements, and selecting
project participants.
2. Maximization of efficient resource utilization through procurement of labor,
materials and equipment according to the prescribed schedule and plan.
3. Implementation of various operations through proper coordination and
control of planning, design, estimating, contracting and construction in the
entire process.
4. Development of effective communications and mechanisms for resolving
conflicts among the various participants.

The Project Management Institute focuses on nine distinct areas requiring project
manager knowledge and attention:

1. Project integration management to ensure that the various project elements

are effectively coordinated.
2. Project scope management to ensure that all the work required (and only the
required work) is included.
3. Project time management to provide an effective project schedule.

32
 4. Project cost management to identify needed resources and maintain budget
control.
5. Project quality management to ensure functional requirements are met.
6. Project human resource management to development and effectively employ
project personnel.
7. Project communications management to ensure effective internal and
external communications.
8. Project risk management to analyze and mitigate potential risks.
9. Project procurement management to obtain necessary resources from
external sources.

These nine areas form the basis of the Project Management Institute's certification
program for project managers in any industry. Back to top

2.2 Trends in Modern Management

In recent years, major developments in management reflect the acceptance to
various degrees of the following elements: (1) the management process approach,
(2) the management science and decision support approach, (3) the behavioral
science approach for human resource development, and (4) sustainable competitive
advantage. These four approaches complement each other in current practice, and
provide a useful groundwork for project management.

The management process approach emphasizes the systematic study of

management by identifying management functions in an organization and then
examining each in detail. There is general agreement regarding the functions of
planning, organizing and controlling. A major tenet is that by analyzing
management along functional lines, a framework can be constructed into which all
new management activities can be placed. Thus, the manager's job is regarded as
coordinating a process of interrelated functions, which are neither totally random
nor rigidly predetermined, but are dynamic as the process evolves. Another tenet is
that management principles can be derived from an intellectual analysis of
management functions. By dividing the manager's job into functional components,
principles based upon each function can be extracted. Hence, management
functions can be organized into a hierarchical structure designed to improve
operational efficiency, such as the example of the organization for a manufacturing
company shown in Figure 2-2. The basic management functions are performed by
all managers, regardless of enterprise, activity or hierarchical levels. Finally, the
development of a management philosophy results in helping the manager to
establish relationships between human and material resources. The outcome of
following an established philosophy of operation helps the manager win the support
of the subordinates in achieving organizational objectives.

33
Figure 2-2: Illustrative Hierarchical Structure of Management Functions

The management science and decision support approach contributes to the

development of a body of quantitative methods designed to aid managers in making
complex decisions related to operations and production. In decision support
systems, emphasis is placed on providing managers with relevant information. In
management science, a great deal of attention is given to defining objectives and
constraints, and to constructing mathematical analysis models in solving complex
problems of inventory, materials and production control, among others. A topic of
major interest in management science is the maximization of profit, or in the
absence of a workable model for the operation of the entire system, the
suboptimization of the operations of its components. The optimization or
suboptimization is often achieved by the use of operations research techniques,
such as linear programming, quadratic programming, graph theory, queuing theory
and Monte Carlo simulation. In addition to the increasing use of computers
accompanied by the development of sophisticated mathematical models and
information systems, management science and decision support systems have
played an important role by looking more carefully at problem inputs and
relationships and by promoting goal formulation and measurement of performance.
Artificial intelligence has also begun to be applied to provide decision support
systems for solving ill-structured problems in management.

The behavioral science approach for human resource development is important

because management entails getting things done through the actions of people. An

34
effective manager must understand the importance of human factors such as needs,
drives, motivation, leadership, personality, behavior, and work groups. Within this
context, some place more emphasis on interpersonal behavior which focuses on the
individual and his/her motivations as a socio-psychological being; others
emphasize more group behavior in recognition of the organized enterprise as a
social organism, subject to all the attitudes, habits, pressures and conflicts of the
cultural environment of people. The major contributions made by the behavioral
scientists to the field of management include: (1) the formulation of concepts and
explanations about individual and group behavior in the organization, (2) the
empirical testing of these concepts methodically in many different experimental
and field settings, and (3) the establishment of actual managerial policies and
decisions for operation based on the conceptual and methodical frameworks.

Sustainable competitive advantage stems primarily from good management

strategy. As Michael Porter of the Harvard Business School argues:

Strategy is creating fit among a company's activities. The success of a strategy

depends on doing many things well - not just a few - and integrating among them.
If there is no fit among activites, there is no distinctive strategy and little
sustainability.
In this view, successful firms must improve and align the many processes
underway to their strategic vision. Strategic positioning in this fashion requires:

• Creating a unique and valuable position.

• Making trade-offs compared to competitors
• Creating a "fit" among a company's activities.

Project managers should be aware of the strategic position of their own

organization and the other organizations involved in the project. The project
manager faces the difficult task of trying to align the goals and strategies of these
various organizations to accomplish the project goals. For example, the owner of an
industrial project may define a strategic goal as being first to market with new
products. In this case, facilities development must be oriented to fast-track, rapid
construction. As another example, a contracting firm may see their strategic
advantage in new technologies and emphasize profit opportunities from value
engineering (as described in Chapter 3).
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2.3 Strategic Planning and Project Programming

The programming of capital projects is shaped by the strategic plan of an
organization, which is influenced by market demands and resources constraints.
The programming process associated with planning and feasibility studies sets the
priorities and timing for initiating various projects to meet the overall objectives of

35
the organizations. However, once this decision is made to initiate a project, market
pressure may dictate early and timely completion of the facility.

Among various types of construction, the influence of market pressure on the

timing of initiating a facility is most obvious in industrial construction. [3] Demand
for an industrial product may be short-lived, and if a company does not hit the
market first, there may not be demand for its product later. With intensive
competition for national and international markets, the trend of industrial
construction moves toward shorter project life cycles, particularly in technology
intensive industries.

In order to gain time, some owners are willing to forego thorough planning and
feasibility study so as to proceed on a project with inadequate definition of the
project scope. Invariably, subsequent changes in project scope will increase
construction costs; however, profits derived from earlier facility operation often
justify the increase in construction costs. Generally, if the owner can derive
reasonable profits from the operation of a completed facility, the project is
considered a success even if construction costs far exceed the estimate based on an
inadequate scope definition. This attitude may be attributed in large part to the
uncertainties inherent in construction projects. It is difficult to argue that profits
might be even higher if construction costs could be reduced without increasing the
project duration. However, some projects, notably some nuclear power plants, are
clearly unsuccessful and abandoned before completion, and their demise must be
attributed at least in part to inadequate planning and poor feasibility studies.

The owner or facility sponsor holds the key to influence the construction costs of a
project because any decision made at the beginning stage of a project life cycle has
far greater influence than those made at later stages, as shown schematically in
Figure 2-3. Moreover, the design and construction decisions will influence the
continuing operating costs and, in many cases, the revenues over the facility
lifetime. Therefore, an owner should obtain the expertise of professionals to
provide adequate planning and feasibility studies. Many owners do not maintain an
in-house engineering and construction management capability, and they should
consider the establishment of an ongoing relationship with outside consultants in
order to respond quickly to requests. Even among those owners who maintain
engineering and construction divisions, many treat these divisions as reimbursable,
independent organizations. Such an arrangement should not discourage their
legitimate use as false economies in reimbursable costs from such divisions can
indeed be very costly to the overall organization.

36
Figure 2-3: Ability to Influence Construction Cost Over Time

Finally, the initiation and execution of capital projects places demands on the
resources of the owner and the professionals and contractors to be engaged by the
owner. For very large projects, it may bid up the price of engineering services as
well as the costs of materials and equipment and the contract prices of all types.
Consequently, such factors should be taken into consideration in determining the
timing of a project.

Example 2-1: Setting priorities for projects

A department store planned to expand its operation by acquiring 20 acres of land in

the southeast of a metropolitan area which consists of well established suburbs for
middle income families. An architectural/engineering (A/E) firm was engaged to
design a shopping center on the 20-acre plot with the department store as its
flagship plus a large number of storefronts for tenants. One year later, the
department store owner purchased 2,000 acres of farm land in the northwest
outskirts of the same metropolitan area and designated 20 acres of this land for a
shopping center. The A/E firm was again engaged to design a shopping center at
this new location.

The A/E firm was kept completely in the dark while the assemblage of the 2,000
acres of land in the northwest quietly took place. When the plans and specifications
for the southeast shopping center were completed, the owner informed the A/E firm

37
that it would not proceed with the construction of the southeast shopping center for
the time being. Instead, the owner urged the A/E firm to produce a new set of
similar plans and specifications for the northwest shopping center as soon as
possible, even at the sacrifice of cost saving measures. When the plans and
specifications for the northwest shopping center were ready, the owner immediately
authorized its construction. However, it took another three years before the
southeast shopping center was finally built.

The reason behind the change of plan was that the owner discovered the availability
of the farm land in the northwest which could be developed into residential real
estate properties for upper middle income families. The immediate construction of
the northwest shopping center would make the land development parcels more
attractive to home buyers. Thus, the owner was able to recoup enough cash flow in
three years to construct the southeast shopping center in addition to financing the
construction of the northeast shopping center, as well as the land development in its
vicinity.

While the owner did not want the construction cost of the northwest shopping
center to run wild, it apparently was satisfied with the cost estimate based on the
detailed plans of the southeast shopping center. Thus, the owner had a general idea
of what the construction cost of the northwest shopping center would be, and did
not wish to wait for a more refined cost estimate until the detailed plans for that
center were ready. To the owner, the timeliness of completing the construction of
the northwest shopping center was far more important than reducing the
construction cost in fulfilling its investment objectives.

Example 2-2: Resource Constraints for Mega Projects

A major problem with mega projects is the severe strain placed on the environment,
particularly on the resources in the immediate area of a construction project.
"Mega" or "macro" projects involve construction of very large facilities such as the
Alaska pipeline constructed in the 1970's or the Panama Canal constructed in the
1900's. The limitations in some or all of the basic elements required for the
successful completion of a mega project include:

• engineering design professionals to provide sufficient manpower to complete

the design within a reasonable time limit.
• construction supervisors with capacity and experience to direct large
projects.
• the number of construction workers with proper skills to do the work.
• the market to supply materials in sufficient quantities and of required quality
on time.
• the ability of the local infrastructure to support the large number of workers
over an extended period of time, including housing, transportation and other
services.

38
To compound the problem, mega projects are often constructed in remote
environments away from major population centers and subject to severe climate
conditions. Consequently, special features of each mega project must be evaluated
carefully.

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2.4 Effects of Project Risks on Organization

The uncertainty in undertaking a construction project comes from many sources
and often involves many participants in the project. Since each participant tries to
minimize its own risk, the conflicts among various participants can be detrimental
to the project. Only the owner has the power to moderate such conflicts as it alone
holds the key to risk assignment through proper contractual relations with other
participants. Failure to recognize this responsibility by the owner often leads to
undesirable results. In recent years, the concept of "risk sharing/risk assignment"
contracts has gained acceptance by the federal government. [4] Since this type of
contract acknowledges the responsibilities of the owners, the contract prices are
expected to be lower than those in which all risks are assigned to contractors.

In approaching the problem of uncertainty, it is important to recognize that

incentives must be provided if any of the participants is expected to take a greater
risk. The willingness of a participant to accept risks often reflects the professional
competence of that participant as well as its propensity to risk. However, society's
perception of the potential liabilities of the participant can affect the attitude of
risk-taking for all participants. When a claim is made against one of the
participants, it is difficult for the public to know whether a fraud has been
committed, or simply that an accident has occurred.

Risks in construction projects may be classified in a number of ways. [5] One form
of classification is as follows:

1. Socioeconomic factors
o Environmental protection
o Public safety regulation
o Economic instability
o Exchange rate fluctuation
2. Organizational relationships
o Contractual relations
o Attitudes of participants
o Communication
3. Technological problems
o Design assumptions
o Site conditions
o Construction procedures

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 o Construction occupational safety

The environmental protection movement has contributed to the uncertainty for

construction because of the inability to know what will be required and how long it
will take to obtain approval from the regulatory agencies. The requirements of
continued re-evaluation of problems and the lack of definitive criteria which are
practical have also resulted in added costs. Public safety regulations have similar
effects, which have been most noticeable in the energy field involving nuclear
power plants and coal mining. The situation has created constantly shifting
guidelines for engineers, constructors and owners as projects move through the
stages of planning to construction. These moving targets add a significant new
dimension of uncertainty which can make it virtually impossible to schedule and
complete work at budgeted cost. Economic conditions of the past decade have
further reinforced the climate of uncertainty with high inflation and interest rates.
The deregulation of financial institutions has also generated unanticipated problems
related to the financing of construction.

Uncertainty stemming from regulatory agencies, environmental issues and financial

aspects of construction should be at least mitigated or ideally eliminated. Owners
are keenly interested in achieving some form of breakthrough that will lower the
costs of projects and mitigate or eliminate lengthy delays. Such breakthroughs are
seldom planned. Generally, they happen when the right conditions exist, such as
when innovation is permitted or when a basis for incentive or reward exists.
However, there is a long way to go before a true partnership of all parties involved
can be forged.

During periods of economic expansion, major capital expenditures are made by

industries and bid up the cost of construction. In order to control costs, some
owners attempt to use fixed price contracts so that the risks of unforeseen
contingencies related to an overheated economy are passed on to contractors.
However, contractors will raise their prices to compensate for the additional risks.

The risks related to organizational relationships may appear to be unnecessary but

are quite real. Strained relationships may develop between various organizations
involved in the design/construct process. When problems occur, discussions often
center on responsibilities rather than project needs at a time when the focus should
be on solving the problems. Cooperation and communication between the parties
are discouraged for fear of the effects of impending litigation. This barrier to
communication results from the ill-conceived notion that uncertainties resulting
from technological problems can be eliminated by appropriate contract terms. The
net result has been an increase in the costs of constructed facilities.

The risks related to technological problems are familiar to the design/construct

professions which have some degree of control over this category. However,
because of rapid advances in new technologies which present new problems to

40
designers and constructors, technological risk has become greater in many
instances. Certain design assumptions which have served the professions well in
the past may become obsolete in dealing with new types of facilities which may
have greater complexity or scale or both. Site conditions, particularly subsurface
conditions which always present some degree of uncertainty, can create an even
greater degree of uncertainty for facilities with heretofore unknown characteristics
during operation. Because construction procedures may not have been fully
anticipated, the design may have to be modified after construction has begun. An
example of facilities which have encountered such uncertainty is the nuclear power
plant, and many owners, designers and contractors have suffered for undertaking
such projects.

If each of the problems cited above can cause uncertainty, the combination of such
problems is often regarded by all parties as being out of control and inherently
risky. Thus, the issue of liability has taken on major proportions and has influenced
the practices of engineers and constructors, who in turn have influenced the actions
of the owners.

Many owners have begun to understand the problems of risks and are seeking to
address some of these problems. For example, some owners are turning to those
organizations that offer complete capabilities in planning, design, and construction,
and tend to avoid breaking the project into major components to be undertaken
individually by specialty participants. Proper coordination throughout the project
duration and good organizational communication can avoid delays and costs
resulting from fragmentation of services, even though the components from various
services are eventually integrated.

Attitudes of cooperation can be readily applied to the private sector, but only in
special circumstances can they be applied to the public sector. The ability to deal
with complex issues is often precluded in the competitive bidding which is usually
required in the public sector. The situation becomes more difficult with the
proliferation of regulatory requirements and resulting delays in design and
construction while awaiting approvals from government officials who do not
participate in the risks of the project.

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2.5 Organization of Project Participants

The top management of the owner sets the overall policy and selects the
appropriate organization to take charge of a proposed project. Its policy will dictate
how the project life cycle is divided among organizations and which professionals
should be engaged. Decisions by the top management of the owner will also
influence the organization to be adopted for project management. In general, there
are many ways to decompose a project into stages. The most typical ways are:

41
 • Sequential processing whereby the project is divided into separate stages and
each stage is carried out successively in sequence.
• Parallel processing whereby the project is divided into independent parts
such that all stages are carried out simultaneously.
• Staggered processing whereby the stages may be overlapping, such as the
use of phased design-construct procedures for fast track operation.

It should be pointed out that some decompositions may work out better than others,
depending on the circumstances. In any case, the prevalence of decomposition
makes the subsequent integration particularly important. The critical issues
involved in organization for project management are:

• How many organizations are involved?

• What are the relationships among the organizations?
• When are the various organizations brought into the project?

There are two basic approaches to organize for project implementation, even
though many variations may exist as a result of different contractual relationships
adopted by the owner and builder. These basic approaches are divided along the
following lines:

1. Separation of organizations. Numerous organizations serve as consultants

or contractors to the owner, with different organizations handling design and
construction functions. Typical examples which involve different degrees of
separation are:
o Traditional sequence of design and construction
o Professional construction management
2. Integration of organizations. A single or joint venture consisting of a
number of organizations with a single command undertakes both design and
construction functions. Two extremes may be cited as examples:
o Owner-builder operation in which all work will be handled in house
by force account.
o Turnkey operation in which all work is contracted to a vendor which
is responsible for delivering the completed project

Since construction projects may be managed by a spectrum of participants in a

variety of combinations, the organization for the management of such projects may
vary from case to case. On one extreme, each project may be staffed by existing
personnel in the functional divisions of the organization on an ad-hoc basis as
shown in Figure 2-4 until the project is completed. This arrangement is referred to
as the matrix organization as each project manager must negotiate all resources for
the project from the existing organizational framework. On the other hand, the
organization may consist of a small central functional staff for the exclusive
purpose of supporting various projects, each of which has its functional divisions as
shown in Figure 2-5. This decentralized set-up is referred to as the project oriented

42
organization as each project manager has autonomy in managing the project. There
are many variations of management style between these two extremes, depending
on the objectives of the organization and the nature of the construction project. For
example, a large chemical company with in-house staff for planning, design and
construction of facilities for new product lines will naturally adopt the matrix
organization. On the other hand, a construction company whose existence depends
entirely on the management of certain types of construction projects may find the
project-oriented organization particularly attractive. While organizations may
differ, the same basic principles of management structure are applicable to most
situations.

Figure 2-4: A Matrix Organization

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Figure 2-5: A Project-Oriented Organization

To illustrate various types of organizations for project management, we shall

consider two examples, the first one representing an owner organization while the
second one representing the organization of a construction management consultant
under the direct supervision of the owner.

Example 2-3: Matrix Organization of an Engineering Division

The Engineering Division of an Electric Power and Light Company has functional
departments as shown in Figure 2-6. When small scale projects such as the addition
of a transmission tower or a sub-station are authorized, a matrix organization is
used to carry out such projects. For example, in the design of a transmission tower,
the professional skill of a structural engineer is most important. Consequently, the
leader of the project team will be selected from the Structural Engineering
Department while the remaining team members are selected from all departments
as dictated by the manpower requirements. On the other hand, in the design of a
new sub-station, the professional skill of an electrical engineer is most important.
Hence, the leader of the project team will be selected from the Electrical
Engineering Department.

44
Figure 2-6: The Matrix Organization in an Engineering Division

Example 2-4: Example of Construction Management Consultant

Organization

When the same Electric Power and Light Company in the previous example
decided to build a new nuclear power plant, it engaged a construction management
consultant to take charge of the design and construction completely. However, the
company also assigned a project team to coordinate with the construction
management consultant as shown in Figure 2-7.

45
Figure 2-7: Coordination between Owner and Consultant

Since the company eventually will operate the power plant upon its completion, it
is highly important for its staff to monitor the design and construction of the plant.
Such coordination allows the owner not only to assure the quality of construction
but also to be familiar with the design to facilitate future operation and
maintenance. Note the close direct relationships of various departments of the
owner and the consultant. Since the project will last for many years before its
completion, the staff members assigned to the project team are not expected to
rejoin the Engineering Department but will probably be involved in the future
operation of the new plant. Thus, the project team can act independently toward its
designated mission.

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2.6 Traditional Designer-Constructor Sequence

For ordinary projects of moderate size and complexity, the owner often employs a
designer (an architectural/engineering firm) which prepares the detailed plans and
specifications for the constructor (a general contractor). The designer also acts on
behalf of the owner to oversee the project implementation during construction. The

46
general contractor is responsible for the construction itself even though the work
may actually be undertaken by a number of specialty subcontractors.

The owner usually negotiates the fee for service with the architectural/engineering
(A/E) firm. In addition to the responsibilities of designing the facility, the A/E firm
also exercises to some degree supervision of the construction as stipulated by the
owner. Traditionally, the A/E firm regards itself as design professionals
representing the owner who should not communicate with potential contractors to
avoid collusion or conflict of interest. Field inspectors working for an A/E firm
usually follow through the implementation of a project after the design is
completed and seldom have extensive input in the design itself. Because of the
litigation climate in the last two decades, most A/E firms only provide observers
rather than inspectors in the field. Even the shop drawings of fabrication or
construction schemes submitted by the contractors for approval are reviewed with a
disclaimer of responsibility by the A/E firms.

The owner may select a general constructor either through competitive bidding or
through negotiation. Public agencies are required to use the competitive bidding
mode, while private organizations may choose either mode of operation. In using
competitive bidding, the owner is forced to use the designer-constructor sequence
since detailed plans and specifications must be ready before inviting bidders to
submit their bids. If the owner chooses to use a negotiated contract, it is free to use
phased construction if it so desires.

The general contractor may choose to perform all or part of the construction work,
or act only as a manager by subcontracting all the construction to subcontractors.
The general contractor may also select the subcontractors through competitive
bidding or negotiated contracts. The general contractor may ask a number of
subcontractors to quote prices for the subcontracts before submitting its bid to the
owner. However, the subcontractors often cannot force the winning general
contractor to use them on the project. This situation may lead to practices known
as bid shopping and bid peddling. Bid shopping refers to the situation when the
general contractor approaches subcontractors other than those whose quoted prices
were used in the winning contract in order to seek lower priced subcontracts. Bid
peddling refers to the actions of subcontractors who offer lower priced subcontracts
to the winning general subcontractors in order to dislodge the subcontractors who
originally quoted prices to the general contractor prior to its bid submittal. In both
cases, the quality of construction may be sacrificed, and some state statutes forbid
these practices for public projects.

Although the designer-constructor sequence is still widely used because of the

public perception of fairness in competitive bidding, many private owners
recognize the disadvantages of using this approach when the project is large and
complex and when market pressures require a shorter project duration than that
which can be accomplished by using this traditional method.

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Back to top

2.7 Professional Construction Management

Professional construction management refers to a project management team
consisting of a professional construction manager and other participants who will
carry out the tasks of project planning, design and construction in an integrated
manner. Contractual relationships among members of the team are intended to
minimize adversarial relationships and contribute to greater response within the
management group. A professional construction manager is a firm specialized in
the practice of professional construction management which includes:

• Work with owner and the A/E firms from the beginning and make
recommendations on design improvements, construction technology,
schedules and construction economy.
• Propose design and construction alternatives if appropriate, and analyze the
effects of the alternatives on the project cost and schedule.
• Monitor subsequent development of the project in order that these targets are
not exceeded without the knowledge of the owner.
• Coordinate procurement of material and equipment and the work of all
construction contractors, and monthly payments to contractors, changes,
claims and inspection for conforming design requirements.
• Perform other project related services as required by owners.

Professional construction management is usually used when a project is very large

or complex. The organizational features that are characteristics of mega-projects
can be summarized as follows:[6]

• The overall organizational approach for the project will change as the project
advances. The "functional" organization may change to a "matrix" which
may change to a "project" organization (not necessarily in this order).
• Within the overall organization, there will probably be functional, project,
and matrix suborganizations all at the same time. This feature greatly
complicates the theory and the practice of management, yet is essential for
overall cost effectiveness.
• Successful giant, complex organizations usually have a strong matrix-type
suborganization at the level where basic cost and schedule control
responsibility is assigned. This suborganization is referred to as a "cost
center" or as a "project" and is headed by a project manager. The cost center
matrix may have participants assigned from many different functional
groups. In turn, these functional groups may have technical reporting
responsibilities to several different and higher tiers in the organization. The
key to a cost effective effort is the development of this project
suborganization into a single team under the leadership of a strong project
manager.

48
 • The extent to which decision-making will be centralized or decentralized is
crucial to the organization of the mega-project.

Consequently, it is important to recognize the changing nature of the organizational

structure as a project is carried out in various stages.

Example 2-5: Managing of the Alaska Pipeline Project

The Alaska Pipeline Project was the largest, most expensive private construction
project in the 1970's, which encompassed 800 miles, thousands of employees, and
10 billion dollars.

At the planning stage, the owner (a consortium) employed a Construction

Management Contractor (CMC) to direct the pipeline portion, but retained
centralized decision making to assure single direction and to integrate the effort of
the CMC with the pump stations and the terminals performed by another
contractor. The CMC also centralized its decision making in directing over 400
subcontractors and thousands of vendors. Because there were 19 different
construction camps and hundreds of different construction sites, this centralization
caused delays in decision making.

At about the 15% point of physical completion, the owner decided to reorganize the
decision making process and change the role of the CMC. The new organization
was a combination of owner and CMC personnel assigned within an integrated
organization. The objective was to develop a single project team responsible for
controlling all subcontractors. Instead of having nine tiers of organization from the
General Manager of the CMC to the subcontractors, the new organization had only
four tiers from the Senior Project Manager of the owner to subcontractors. Besides
unified direction and coordination, this reduction in tiers of organization greatly
improved communications and the ability to make and implement decisions. The
new organization also allowed decentralization of decision making by treating five
sections of the pipeline at different geographic locations as separate projects, with a
section manager responsible for all functions of the section as a profit center.

At about 98% point of physical completion, all remaining activities were to be

consolidated to identify single bottom-line responsibility, to reduce duplication in
management staff, and to unify coordination of remaining work. Thus, the project
was first handled by separate organizations but later was run by an integrated
organization with decentralized profit centers. Finally, the organization in effect
became small and was ready to be phased out of operation.

Example 2-6: Managing the Channel Tunnel Construction from Britain to

France

49
The underground railroad tunnel from Britain to France is commonly called the
Channel Tunnel or Chunnel. It was built by tunneling from each side. Starting in
1987, the tunnels had a breakthough in 1990.

Management turmoil dogged the project from the start. In 1989, seven of the eight
top people in the construction organization left. There was a built in conflict
between the contractors and government overseers: "The fundamental thing wrong
is that the constractors own less than 6% of Eurotunnel. Their interest is to build
and sell the project at a profit. (Eurotunnel's) interest is for it to operate
economically, safely and reliably for the next 50 years." (Alastair Morton,
Eurotunnel CEO, quoted in ENR, 12/10/90, p. 56).

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2.8 Owner-Builder Operation

In this approach an owner must have a steady flow of on-going projects in order to
maintain a large work force for in-house operation. However, the owner may
choose to subcontract a substantial portion of the project to outside consultants and
contractors for both design and construction, even though it retains centralized
decision making to integrate all efforts in project implementation.

Example 2-7: U.S. Army Corps of Engineers Organization

The District Engineer's Office of the U.S. Army Corps of Engineers may be viewed
as a typical example of an owner-builder approach as shown in Figure 2-8.

Figure 2-8: Organization of a District of Corps of Engineers

50
In the District Engineer's Office of the U.S. Corps of Engineers, there usually exist
an Engineering Division and an Operations Division, and, in a large district, a
Construction Division. Under each division, there are several branches. Since the
authorization of a project is usually initiated by the U.S. Congress, the planning and
design functions are separated in order to facilitate operations. Since the
authorization of the feasibility study of a project may precede the authorization of
the design by many years, each stage can best be handled by a different branch in
the Engineering Division. If construction is ultimately authorized, the work may be
handled by the Construction Division or by outside contractors. The Operations
Division handles the operation of locks and other facilities which require routine
attention and maintenance.

When a project is authorized, a project manager is selected from the most

appropriate branch to head the project, together with a group of staff drawn from
various branches to form the project team. When the project is completed, all
members of the team including the project manager will return to their regular posts
in various branches and divisions until the next project assignment. Thus, a matrix
organization is used in managing each project.

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2.9 Turnkey Operation

Some owners wish to delegate all responsibilities of design and construction to
outside consultants in a turnkey project arrangement. A contractor agrees to provide
the completed facility on the basis of performance specifications set forth by the
owner. The contractor may even assume the responsibility of operating the project
if the owner so desires. In order for a turnkey operation to succeed, the owner must
be able to provide a set of unambiguous performance specifications to the
contractor and must have complete confidence in the capability of the contractor to
carry out the mission.

This approach is the direct opposite of the owner-builder approach in which the
owner wishes to retain the maximum amount of control for the design-construction
process.

Example 2-8: An Example of a Turnkey Organization

A 150-Mw power plant was proposed in 1985 by the Texas-New Mexico Power
Company of Fort Worth, Texas, which would make use of the turnkey
operation. [7] Upon approval by the Texas Utility Commission, a consortium
consisting of H.B. Zachry Co., Westinghouse Electric Co., and Combustion
Engineering, Inc. would design, build and finance the power plant for completion
in 1990 for an estimated construction cost of $200 million in 1990 dollars. The
consortium would assume total liability during construction, including debt service

51
costs, and thereby eliminate the risks of cost escalation to rate payers, stockholders
and the utility company management.

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2.10 Leadership and Motivation for the Project Team

The project manager, in the broadest sense of the term, is the most important
person for the success or failure of a project. The project manager is responsible for
planning, organizing and controlling the project. In turn, the project manager
receives authority from the management of the organization to mobilize the
necessary resources to complete a project.

The project manager must be able to exert interpersonal influence in order to lead
the project team. The project manager often gains the support of his/her team
through a combination of the following:

• Formal authority resulting from an official capacity which is empowered to

issue orders.
• Reward and/or penalty power resulting from his/her capacity to dispense
directly or indirectly valued organization rewards or penalties.
• Expert power when the project manager is perceived as possessing special
knowledge or expertise for the job.
• Attractive power because the project manager has a personality or other
characteristics to convince others.

In a matrix organization, the members of the functional departments may be

accustomed to a single reporting line in a hierarchical structure, but the project
manager coordinates the activities of the team members drawn from functional
departments. The functional structure within the matrix organization is responsible
for priorities, coordination, administration and final decisions pertaining to project
implementation. Thus, there are potential conflicts between functional divisions
and project teams. The project manager must be given the responsibility and
authority to resolve various conflicts such that the established project policy and
quality standards will not be jeopardized. When contending issues of a more
fundamental nature are developed, they must be brought to the attention of a high
level in the management and be resolved expeditiously.

In general, the project manager's authority must be clearly documented as well as

defined, particularly in a matrix organization where the functional division
managers often retain certain authority over the personnel temporarily assigned to a
project. The following principles should be observed:

• The interface between the project manager and the functional division
managers should be kept as simple as possible.

52
 • The project manager must gain control over those elements of the project
which may overlap with functional division managers.
• The project manager should encourage problem solving rather than role
playing of team members drawn from various functional divisions.

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2.11 Interpersonal Behavior in Project Organizations

While a successful project manager must be a good leader, other members of the
project team must also learn to work together, whether they are assembled from
different divisions of the same organization or even from different organizations.
Some problems of interaction may arise initially when the team members are
unfamiliar with their own roles in the project team, particularly for a large and
complex project. These problems must be resolved quickly in order to develop an
effective, functioning team.

Many of the major issues in construction projects require effective interventions by

individuals, groups and organizations. The fundamental challenge is to enhance
communication among individuals, groups and organizations so that obstacles in
the way of improving interpersonal relations may be removed. Some behavior
science concepts are helpful in overcoming communication difficulties that block
cooperation and coordination. In very large projects, professional behavior
scientists may be necessary in diagnosing the problems and advising the personnel
working on the project. The power of the organization should be used judiciously
in resolving conflicts.

The major symptoms of interpersonal behavior problems can be detected by

experienced observers, and they are often the sources of serious communication
difficulties among participants in a project. For example, members of a project
team may avoid each other and withdraw from active interactions about differences
that need to be dealt with. They may attempt to criticize and blame other
individuals or groups when things go wrong. They may resent suggestions for
improvement, and become defensive to minimize culpability rather than take the
initiative to maximize achievements. All these actions are detrimental to the project
organization.

While these symptoms can occur to individuals at any organization, they are
compounded if the project team consists of individuals who are put together from
different organizations. Invariably, different organizations have different cultures or
modes of operation. Individuals from different groups may not have a common
loyalty and may prefer to expand their energy in the directions most advantageous
to themselves instead of the project team. Therefore, no one should take it for
granted that a project team will work together harmoniously just because its
members are placed physically together in one location. On the contrary, it must be

53
assumed that good communication can be achieved only through the deliberate
effort of the top management of each organization contributing to the joint venture.

Back to top

2.12 Perceptions of Owners and Contractors

Although owners and contractors may have different perceptions on project
management for construction, they have a common interest in creating an
environment leading to successful projects in which performance quality,
completion time and final costs are within prescribed limits and tolerances. It is
interesting therefore to note the opinions of some leading contractors and owners
who were interviewed in 1984. [8]

From the responses of six contractors, the key factors cited for successful projects
are:

• well defined scope

• extensive early planning
• good leadership, management and first line supervision
• positive client relationship with client involvement
• proper project team chemistry
• quick response to changes
• engineering managers concerned with the total project, not just the
engineering elements.

Conversely, the key factors cited for unsuccessful projects are:

• ill-defined scope
• poor management
• poor planning
• breakdown in communication between engineering and construction
• unrealistic scope, schedules and budgets
• many changes at various stages of progress
• lack of good project control

The responses of eight owners indicated that they did not always understand the
concerns of the contractors although they generally agreed with some of the key
factors for successful and unsuccessful projects cited by the contractors. The
significant findings of the interviews with owners are summarized as follows:

• All owners have the same perception of their own role, but they differ
significantly in assuming that role in practice.
• The owners also differ dramatically in the amount of early planning and in
providing information in bid packages.

54
 • There is a trend toward breaking a project into several smaller projects as the
projects become larger and more complex.
• Most owners recognize the importance of schedule, but they adopt different
requirements in controlling the schedule.
• All agree that people are the key to project success.

From the results of these interviews, it is obvious that owners must be more aware
and involved in the process in order to generate favorable conditions for successful
projects. Design professionals and construction contractors must provide better
communication with each other and with the owner in project implementation.

Back to top

2.13 References
1. Barrie, Donald S. and Boyd C. Paulson, Jr., Professional Construction
Management, McGraw-Hill Book Company, 2nd Ed., 1984.
2. Halpin, Daniel W. and Ronald W. Woodhead, Construction Management,
John Wiley and Sons, 1980.
3. Hodgetts, R.M., Management: Theory, Process and Practice, W.B. Saunders
Co., Philadelphia, PA, 1979.
4. Kerzner, H. Project Management: A Systems Approach to Planning,
Scheduling and Controlling. 2nd. Ed., Van Nostrand Reinhold, New York,
1984.
5. Levitt, R.E., R.D. Logcher and N.H. Quaddumi, "Impact of Owner-Engineer
Risk Sharing on Design Conservatism," ASCE Journal of Professional
Issues in Engineering, Vol. 110, 1984, pp. 157-167.
6. Moolin, F.P., Jr., and F.A. McCoy: "Managing the Alaska Pipeline
Project," Civil Engineering, November 1981, pp. 51-54.
7. Murray, L., E. Gallardo, S. Aggarwal and R. Waywitka, "Marketing
Construction Management Services," ASCE Journal of Construction
Division, Vol. 107, 1981, pp. 665-677.
8. Project Management Institute, A Guide to the Project Management Body of
Knowledge, Newtown Square, Pennsylvania, 2000.

Back to top

2.14 Footnotes
1. See R. M. Wideman, "The PMBOK Report -- PMI Body of Knowledge
Standard," Project Management Journal, Vol. 17, No. 3, August l986, pp.
l5-24. Back
2. See L. C. Stuckenbruck, "Project Management Framework," Project
Management Journal, Vol. 17, No. 3, August 1986, pp. 25-30. Back

55
3. See, for example, O'Connor, J.T., and Vickory, C.G., Control of
Construction Project Scope, A Report to the Construction Industry Institute,
The University of Texas at Austin, December 1985. Back
4. See, for example, Federal Form 23-A and EPA's Appendix C-
2 clauses. Back
5. See E. D'Appolonia, "Coping with Uncertainty in Geotechnical Engineering
and Construction," Special Proceedings of the 9th International Conference
on Soil Mechanics and Foundation Engineering, Tokyo, Japan, Vol. 4, 1979,
pp. 1-18. Back
6. These features and the following example are described in F.P. Moolin, Jr.
and F.A. McCoy, "Managing the Alaska Pipeline Project," Civil
Engineering, November 1981, pp. 51-54. Back
7. "Private Money Finances Texas Utility's Power Plant" Engineering News
Record: July 25, 1985, p. 13. Back
8. See J.E. Diekmann and K.B. Thrush, Project Control in Design
Engineering, A Report to the Construction Industry Institute, The University
of Texas at Austin, Texas, May 1986. Back

56
3. The Design and Construction Process
3.1 Design and Construction as an Integrated System
In the planning of facilities, it is important to recognize the close relationship
between design and construction. These processes can best be viewed as an
integrated system. Broadly speaking, design is a process of creating the description
of a new facility, usually represented by detailed plans and specifications;
construction planning is a process of identifying activities and resources required to
make the design a physical reality. Hence, construction is the implementation of a
design envisioned by architects and engineers. In both design and construction,
numerous operational tasks must be performed with a variety of precedence and
other relationships among the different tasks.

Several characteristics are unique to the planning of constructed facilities and

should be kept in mind even at the very early stage of the project life cycle. These
include the following:

• Nearly every facility is custom designed and constructed, and often requires
a long time to complete.
• Both the design and construction of a facility must satisfy the conditions
peculiar to a specific site.
• Because each project is site specific, its execution is influenced by natural,
social and other locational conditions such as weather, labor supply, local
building codes, etc.
• Since the service life of a facility is long, the anticipation of future
requirements is inherently difficult.
• Because of technological complexity and market demands, changes of
design plans during construction are not uncommon.

In an integrated system, the planning for both design and construction can proceed
almost simultaneously, examining various alternatives which are desirable from
both viewpoints and thus eliminating the necessity of extensive revisions under the
guise of value engineering. Furthermore, the review of designs with regard to their
constructibility can be carried out as the project progresses from planning to design.
For example, if the sequence of assembly of a structure and the critical loadings on
the partially assembled structure during construction are carefully considered as a
part of the overall structural design, the impacts of the design on construction
falsework and on assembly details can be anticipated. However, if the design
professionals are expected to assume such responsibilities, they must be rewarded
for sharing the risks as well as for undertaking these additional tasks. Similarly,
when construction contractors are expected to take over the responsibilities of
engineers, such as devising a very elaborate scheme to erect an unconventional

57
structure, they too must be rewarded accordingly. As long as the owner does not
assume the responsibility for resolving this risk-reward dilemma, the concept of a
truly integrated system for design and construction cannot be realized.

It is interesting to note that European owners are generally more open to new
technologies and to share risks with designers and contractors. In particular, they
are more willing to accept responsibilities for the unforeseen subsurface conditions
in geotechnical engineering. Consequently, the designers and contractors are also
more willing to introduce new techniques in order to reduce the time and cost of
construction. In European practice, owners typically present contractors with a
conceptual design, and contractors prepare detailed designs, which are checked by
the owner's engineers. Those detailed designs may be alternate designs, and
specialty contractors may also prepare detailed alternate designs.

Example 3-1: Responsibility for Shop Drawings

The willingness to assume responsibilities does not come easily from any party in
the current litigious climate of the construction industry in the United States. On
the other hand, if owner, architect, engineer, contractor and other groups that
represent parts of the industry do not jointly fix the responsibilities of various tasks
to appropriate parties, the standards of practice will eventually be set by court
decisions. In an attempt to provide a guide to the entire spectrum of participants in
a construction project, the American Society of Civil Engineers issued a Manual of
Professional Practice entitled Quality in the Constructed Project in 1990. This
manual is intended to help bring a turn around of the fragmentation of activities in
the design and construction process.

Shop drawings represent the assembly details for erecting a structure which should
reflect the intent and rationale of the original structural design. They are prepared
by the construction contractor and reviewed by the design professional. However,
since the responsibility for preparing shop drawings was traditionally assigned to
construction contractors, design professionals took the view that the review process
was advisory and assumed no responsibility for their accuracy. This justification
was ruled unacceptable by a court in connection with the walkway failure at the
Hyatt Hotel in Kansas City in 1985. In preparing the ASCE Manual of Professional
Practice for Quality in the Constructed Project, the responsibilities for preparation
of shop drawings proved to be the most difficult to develop. [1] The reason for this
situation is not difficult to fathom since the responsibilities for the task are diffused,
and all parties must agree to the new responsibilities assigned to each in the
recommended risk-reward relations shown in Table 3-1.

Traditionally, the owner is not involved in the preparation and review of shop
drawings, and perhaps is even unaware of any potential problems. In the
recommended practice, the owner is required to take responsibility for providing

58
adequate time and funding, including approval of scheduling, in order to allow the
design professionals and construction contractors to perform satisfactorily.

Table 3-1 Recommended Responsibility for Shop Drawings

Responsible Party
Task Design Construction
Owner
Professional Contractor
Provide adequate time and funding for shop
Prime
drawing preparation and review
Arrange for structural design Prime
Provide structural design Prime
Establish overall responsibility for connection
Prime
design
Accomplish connection design (by design
Prime
professional)
Alternatively, provide loading requirement and
other information necessary for shop drawing Prime
preparation
Alternatively, accomplish some or all of connection
Prime
design (by constuctor with a licensed P.E.)
Specify shop drawing requirements and procedures Review Prime
Approve proper scheduling Prime Assisting Assisting
Provide shop drawing and submit the drawing on
Prime
schedule
Make timely reviews and approvals Prime
Provide erection procedures, construction bracing,
shoring, means, methods and techniques of Prime
construction, and construction safety

Example 3-2:Model Metro Project in Milan, Italy [2]

Under Italian law, unforeseen subsurface conditions are the owner's responsibility,
not the contractor's. This is a striking difference from U.S. construction practice
where changed conditions clauses and claims and the adequacy of prebid site
investigations are points of contention. In effect, the Italian law means that the
owner assumes those risks. But under the same law, a contractor may elect to
assume the risks in order to lower the bid price and thereby beat the competition.

According to the Technical Director of Rodio, the Milan-based contractor which is

heavily involved in the grouting job for tunneling in the Model Metro project in
Milan, Italy, there are two typical contractual arrangements for specialized
subcontractor firms such as theirs. One is to work on a unit price basis with no
responsibility for the design. The other is what he calls the "nominated
subcontractor" or turnkey method: prequalified subcontractors offer their own

59
designs and guarantee the price, quality, quantities, and, if they wish, the risks of
unforeseen conditions.

At the beginning of the Milan metro project, the Rodio contract ratio was 50/50
unit price and turnkey. The firm convinced the metro owners that they would save
money with the turnkey approach, and the ratio became 80% turnkey. What's more,
in the work packages where Rodio worked with other grouting specialists, those
subcontractors paid Rodio a fee to assume all risks for unforeseen conditions.

Under these circumstances, it was critical that the firm should know the subsurface
conditions as precisely as possible, which was a major reason why the firm
developed a computerized electronic sensing program to predict stratigraphy and
thus control grout mixes, pressures and, most important, quantities.

3.2 Innovation and Technological Feasibility

The planning for a construction project begins with the generation of concepts for a
facility which will meet market demands and owner needs. Innovative concepts in
design are highly valued not for their own sake but for their contributions to
reducing costs and to the improvement of aesthetics, comfort or convenience as
embodied in a well-designed facility. However, the constructor as well as the
design professionals must have an appreciation and full understanding of the
technological complexities often associated with innovative designs in order to
provide a safe and sound facility. Since these concepts are often preliminary or
tentative, screening studies are carried out to determine the overall technological
viability and economic attractiveness without pursuing these concepts in great
detail. Because of the ambiguity of the objectives and the uncertainty of external
events, screening studies call for uninhibited innovation in creating new concepts
and judicious judgment in selecting the appropriate ones for further consideration.

One of the most important aspects of design innovation is the necessity of

communication in the design/construction partnership. In the case of bridge design,
it can be illustrated by the following quotation from Lin and Gerwick concerning
bridge construction: [3]

The great pioneering steel bridges of the United States were built by an open or
covert alliance between designers and constructors. The turnkey approach of
designer-constructor has developed and built our chemical plants, refineries, steel
plants, and nuclear power plants. It is time to ask, seriously, whether we may not
have adopted a restrictive approach by divorcing engineering and construction in
the field of bridge construction.

If a contractor-engineer, by some stroke of genius, were to present to design

engineers today a wonderful new scheme for long span prestressed concrete bridges
that made them far cheaper, he would have to make these ideas available to all

60
other constructors, even limiting or watering them down so as to "get a group of
truly competitive bidders." The engineer would have to make sure that he found
other contractors to bid against the ingenious innovator.

If an engineer should, by a similar stroke of genius, hit on such a unique and

brilliant scheme, he would have to worry, wondering if the low bidder would be
one who had any concept of what he was trying to accomplish or was in any way
qualified for high class technical work.

Innovative design concepts must be tested for technological feasibility. Three levels
of technology are of special concern: technological requirements for operation or
production, design resources and construction technology. The first refers to the
new technologies that may be introduced in a facility which is used for a certain
type of production such as chemical processing or nuclear power generation. The
second refers to the design capabilities that are available to the designers, such as
new computational methods or new materials. The third refers to new technologies
which can be adopted to construct the facility, such as new equipment or new
construction methods.

A new facility may involve complex new technology for operation in hostile
environments such as severe climate or restricted accessibility. Large projects with
unprecedented demands for resources such as labor supply, material and
infrastructure may also call for careful technological feasibility studies. Major
elements in a feasibility study on production technology should include, but are not
limited to, the following:

• Project type as characterized by the technology required, such as synthetic

fuels, petrochemicals, nuclear power plants, etc.
• Project size in dollars, design engineer's hours, construction labor hours, etc.
• Design, including sources of any special technology which require licensing
agreements.
• Project location which may pose problems in environmental protection,
labor productivity and special risks.

An example of innovative design for operation and production is the use of entropy
concepts for the design of integrated chemical processes. Simple calculations can
be used to indicate the minimum energy requirements and the least number of heat
exchange units to achieve desired objectives. The result is a new incentive and
criterion for designers to achieve more effective designs. Numerous applications of
the new methodology has shown its efficacy in reducing both energy costs and
construction expenditures. [4] This is a case in which innovative design is not a
matter of trading-off operating and capital costs, but better designs can
simultaneously achieve improvements in both objectives.

61
The choice of construction technology and method involves
both strategic and tactical decisions about appropriate technologies and the best
sequencing of operations. For example, the extent to which prefabricated facility
components will be used represents a strategic construction decision. In turn,
prefabrication of components might be accomplished off-site in existing
manufacturing facilities or a temporary, on-site fabrication plant might be used.
Another example of a strategic decision is whether to install mechanical equipment
in place early in the construction process or at an intermediate stage. Strategic
decisions of this sort should be integrated with the process of facility design in
many cases. At the tactical level, detailed decisions about how to accomplish
particular tasks are required, and such decisions can often be made in the field.

Construction planning should be a major concern in the development of facility

designs, in the preparation of cost estimates, and in forming bids by contractors.
Unfortunately, planning for the construction of a facility is often treated as an after
thought by design professionals. This contrasts with manufacturing practices in
which the assembly of devices is a major concern in design. Design to insure ease
of assembly or construction should be a major concern of engineers and architects.
As the Business Roundtable noted, "All too often chances to cut schedule time and
costs are lost because construction operates as a production process separated by a
chasm from financial planning, scheduling, and engineering or architectural design.
Too many engineers, separated from field experience, are not up to date about how
to build what they design, or how to design so structures and equipment can be
erected most efficiently." [5]

Example 3-3: Innovative use of structural frames for buildings [6]

The structural design of skyscrapers offers an example of innovation in overcoming

the barrier of high costs for tall buildings by making use of new design capabilities.
A revolutionary concept in skyscraper design was introduced in the 1960's by
Fazlur Khan who argued that, for a building of a given height, there is an
appropriate structural system which would produce the most efficient use of the
material.

Before 1965, most skyscrapers were steel rigid frames. However, Fazlur Khan
believed that it was uneconomical to construct all office buildings of rigid frames,
and proposed an array of appropriate structural systems for steel buildings of
specified heights as shown in Figure 3-1. By choosing an appropriate structural
system, an engineer can use structural materials more efficiently. For example, the
60-story Chase Manhattan Building in New York used about 60 pounds per square
foot of steel in its rigid frame structure, while the 100-story John Hancock Center
in Chicago used only 30 pounds per square foot for a trusted tube system. At the
time the Chase Manhattan Building was constructed, no bracing was used to stiffen
the core of a rigid frame building because design engineers did not have the

62
computing tools to do the complex mathematical analysis associated with core
bracing.

Figure 3-1: Proposed Structural System fir Steel Buildings

(Reprinted with permission from Civil Engineering, May 1983)

3.3 Innovation and Economic Feasibility

Innovation is often regarded as the engine which can introduce construction
economies and advance labor productivity. This is obviously true for certain types
of innovations in industrial production technologies, design capabilities, and
construction equipment and methods. However, there are also limitations due to the
economic infeasibility of such innovations, particularly in the segments of
construction industry which are more fragmented and permit ease of entry, as in the
construction of residential housing.

Market demand and firm size play an important role in this regard. If a builder is to
construct a larger number of similar units of buildings, the cost per unit may be
reduced. This relationship between the market demand and the total cost of
production may be illustrated schematically as in Figure 3-2. An initial threshold or
fixed cost F is incurred to allow any production. Beyond this threshold cost, total
cost increases faster than the units of output but at a decreasing rate. At each point
on this total cost curve, the average cost is represented by the slope of a line from

63
the origin to the point on the curve. At a point H, the average cost per unit is at a
minimum. Beyond H to the right, the total cost again increases faster than the units
of output and at an increasing rate. When the rate of change of the average cost
slope is decreasing or constant as between 0 and H on the curve, the range between
0 and H is said to be increasing return to scale; when the rate of change of the
average cost slope is increasing as beyond H to the right, the region is said to
be decreasing return to scale. Thus, if fewer than h units are constructed, the unit
price will be higher than that of exactly h units. On the other hand, the unit price
will increase again if more than h units are constructed.

Figure 3-2: Market Demand and Total Cost Relationship

Nowhere is the effect of market demand and total cost more evident than in
residential housing. [7] The housing segment in the last few decades accepted
many innovative technical improvements in building materials which were
promoted by material suppliers. Since material suppliers provide products to a large
number of homebuilders and others, they are in a better position to exploit
production economies of scale and to support new product development. However,
homebuilders themselves have not been as successful in making the most
fundamental form of innovation which encompasses changes in the technological
process of homebuilding by shifting the mixture of labor and material inputs, such
as substituting large scale off-site prefabrication for on-site assembly.

There are several major barriers to innovation in the technological process of

homebuilding, including demand instability, industrial fragmentation, and building
codes. Since market demand for new homes follows demographic trends and other
socio-economic conditions, the variation in home building has been anything but
regular. The profitability of the homebuilding industry has closely matched

64
aggregate output levels. Since entry and exist from the industry are relatively easy,
it is not uncommon during periods of slack demand to find builders leaving the
market or suspending their operations until better times. The inconsistent levels of
retained earnings over a period of years, even among the more established builders,
are likely to discourage support for research and development efforts which are
required to nurture innovation. Furthermore, because the homebuilding industry is
fragmented with a vast majority of homebuilders active only in local regions, the
typical homebuilder finds it excessively expensive to experiment with new designs.
The potential costs of a failure or even a moderately successful innovation would
outweigh the expected benefits of all but the most successful innovations. Variation
in local building codes has also caused inefficiencies although repeated attempts
have been made to standardize building codes.

In addition to the scale economies visible within a sector of the construction

market, there are also possibilities for scale economies in individual facility. For
example, the relationship between the size of a building (expressed in square feet)
and the input labor (expressed in laborhours per square foot) varies for different
types and sizes of buildings. As shown in Figure 3-3, these relationships for several
types of buildings exhibit different characteristics. [8] The labor hours per square
foot decline as the size of facility increases for houses, public housing and public
buildings. However, the labor hours per square foot almost remains constant for all
sizes of school buildings and increases as the size of a hospital facility increases.

65
Figure 3-3: Illustrative Relationships between Building Size and Input Labor by
Types of Building
(Reprinted with permission from P.J. Cassimatis, Economics of the Construction
Industry,
The National Industry Conference Board, SEB, No. 111, 1969, p.53)

Example 3-4: Use of new materials [9]

In recent years, an almost entirely new set of materials is emerging for

construction, largely from the aerospace and electronics industries. These materials
were developed from new knowledge about the structure and properties of
materials as well as new techniques for altering existing materials. Additives to
traditional materials such as concrete and steel are particularly prominent. For
example, it has been known for some time that polymers would increase concrete
strength, water resistance and ability to insulate when they are added to the cement.
However, their use has been limited by their costs since they have had to replace as
much as 10 percent of the cement to be effective. However, Swedish researchers
have helped reduce costs by using polymer microspheres 8 millionths of an inch
across, which occupy less than 1 percent of the cement. Concretes made with these
microspheres meet even the strict standards for offshore structures in the North Sea.

66
Research on micro-additives will probably produce useful concretes for repairing
road and bridges as well.

Example 3-5: Green Buildings[10]

The Leadership in Energy and Environmental Design (LEED) Green Building

Rating System is intended to promote voluntary improvements in design and
construction practices. In the rating system, buildings receive points for a variety of
aspects, including reduced energy use, greater use of daylight rather than artificial
lights, recycling construction waste, rainfall runoff reduction, availability of public
transit access, etc. If a building accumulates a sufficient number of points, it may
be certified by the Green Building Alliance as a "green building." While some of
these aspects may increase construction costs, many reduce operating costs or make
buildings more attractive. Green building approaches are spreading to industrial
plants and other types of construction.

3.4 Design Methodology

While the conceptual design process may be formal or informal, it can be
characterized by a series of actions: formulation, analysis, search, decision,
specification, and modification. However, at the early stage in the development of a
new project, these actions are highly interactive as illustrated in Figure 3-4. [11]
Many iterations of redesign are expected to refine the functional requirements,
design concepts and financial constraints, even though the analytic tools applied to
the solution of the problem at this stage may be very crude.

67
Figure 3-4: Conceptual Design Process
(Adapted with permission from R.W. Jensen and C.C. Tonies, Software
Engineering,
Prentice Hall, Englewood Cliffs, NJ, 1979, p.22)

The series of actions taken in the conceptual design process may be described as
follows:

• Formulation refers to the definition or description of a design problem in

broad terms through the synthesis of ideas describing alternative facilities.
• Analysis refines the problem definition or description by separating
important from peripheral information and by pulling together the essential
detail. Interpretation and prediction are usually required as part of the
analysis.
• Search involves gathering a set of potential solutions for performing the
specified functions and satisfying the user requirements.
• Decision means that each of the potential solutions is evaluated and
compared to the alternatives until the best solution is obtained.
• Specification is to describe the chosen solution in a form which contains
enough detail for implementation.
• Modification refers to the change in the solution or re-design if the solution
is found to be wanting or if new information is discovered in the process of
design.

As the project moves from conceptual planning to detailed design, the design
process becomes more formal. In general, the actions of formulation, analysis,
search, decision, specification and modification still hold, but they represent
specific steps with less random interactions in detailed design. The design
methodology thus formalized can be applied to a variety of design problems. For
example, the analogy of the schematic diagrams of the structural design process
and of the computer program development process is shown in Figure 3-5 [12].

68
69
Figure 3-5: An Analogy Between Structural Design and Computer Program
Development Process
(Reprinted with permission from E.H. Gaylord and C. N. Gaylord, eds., Structural
Engineering Handbook,
2nd Ed., McGraw-Hill Book Company, New York, 1979.)

The basic approach to design relies on decomposition and integration. Since design
problems are large and complex, they have to be decomposed to yield subproblems
that are small enough to solve. There are numerous alternative ways to decompose
design problems, such as decomposition by functions of the facility, by spatial
locations of its parts, or by links of various functions or parts. Solutions to
subproblems must be integrated into an overall solution. The integration often
creates conceptual conflicts which must be identified and corrected. A hierarchical
structure with an appropriate number of levels may be used for the decomposition
of a design problem to subproblems. For example, in the structural design of a
multistory building, the building may be decomposed into floors, and each floor
may in turn be decomposed into separate areas. Thus, a hierarchy representing the
levels of building, floor and area is formed.

Different design styles may be used. The adoption of a particular style often
depends on factors such as time pressure or available design tools, as well as the
nature of the design problem. Examples of different styles are:

• Top-down design. Begin with a behavior description of the facility and

work towards descriptions of its components and their interconnections.
• Bottom-up design. Begin with a set of components, and see if they can be
arranged to meet the behavior description of the facility.

The design of a new facility often begins with the search of the files for a design
that comes as close as possible to the one needed. The design process is guided by
accumulated experience and intuition in the form of heuristic rules to find
acceptable solutions. As more experience is gained for this particular type of
facility, it often becomes evident that parts of the design problem are amenable to
rigorous definition and algorithmic solution. Even formal optimization methods
may be applied to some parts of the problem.

3.5 Functional Design

The objective of functional design for a proposed facility is to treat the facility as a
complex system of interrelated spaces which are organized systematically
according to the functions to be performed in these spaces in order to serve a
collection of needs. The arrangement of physical spaces can be viewed as an
iterative design process to find a suitable floor plan to facilitate the movement of
people and goods associated with the operations intended.

70
A designer often relies on a heuristic approach, i.e., applying selected rules or
strategies serving to stimulate the investigation in search for a solution. The
heuristic approach used in arranging spatial layouts for facilities is based generally
on the following considerations:

1. identification of the goals and constraints for specified tasks,

2. determination of the current state of each task in the iterative design process,
3. evaluation of the differences between the current state and the goals,
4. means of directing the efforts of search towards the goals on the basis of past
experience.

Hence, the procedure for seeking the goals can be recycled iteratively in order to
make tradeoffs and thus improve the solution of spatial layouts.

Consider, for example, an integrated functional design for a proposed

hospital. [13] Since the responsibilities for satisfying various needs in a hospital
are divided among different groups of personnel within the hospital administrative
structure, a hierarchy of functions corresponding to different levels of
responsibilities is proposed in the systematic organization of hospital functions. In
this model, the functions of a hospital system are decomposed into a hierarchy of
several levels:

1. Hospital--conglomerate of all hospital services resulting from top policy

decisions,
2. Division--broadly related activities assigned to the same general area by
administrative decisions,
3. Department--combination of services delivered by a service or treatment
group,
4. Suite--specific style of common services or treatments performed in the
same suite of rooms,
5. Room--all activities that can be carried out in the same internal environment
surrounded by physical barriers,
6. Zone--several closely related activities that are undertaken by individuals,
7. Object--a single activity associated with an individual.

In the integrated functional design of hospitals, the connection between physical

spaces and functions is most easily made at the lowest level of the hierarchy, and
then extended upward to the next higher level. For example, a bed is a physical
object immediately related to the activity of a patient. A set of furniture consisting
of a bed, a night table and an armchair arranged comfortably in a zone indicates the
sphere of private activities for a patient in a room with multiple occupancy. Thus,
the spatial representation of a hospital can be organized in stages starting from the
lowest level and moving to the top. In each step of the organization process, an
element (space or function) under consideration can be related directly to the

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elements at the levels above it, to those at the levels below it, and to those within
the same level.

Since the primary factor relating spaces is the movement of people and supplies,
the objective of arranging spaces is the minimization of movement within the
hospital. On the other hand, the internal environmental factors such as atmospheric
conditions (pressure, temperature, relative humidity, odor and particle pollution),
sound, light and fire protection produce constraining effects on the arrangement of
spaces since certain spaces cannot be placed adjacent to other spaces because of
different requirements in environmental conditions. The consideration of logistics
is important at all levels of the hospital system. For example, the travel patterns
between objects in a zone or those between zones in a room are frequently equally
important for devising an effective design. On the other hand, the adjacency
desirability matrix based upon environmental conditions will not be important for
organization of functional elements below the room level since a room is the lowest
level that can provide a physical barrier to contain desirable environmental
conditions. Hence, the organization of functions for a new hospital can be carried
out through an interactive process, starting from the functional elements at the
lowest level that is regarded as stable by the designer, and moving step by step up
to the top level of the hierarchy. Due to the strong correlation between functions
and the physical spaces in which they are performed, the arrangement of physical
spaces for accommodating the functions will also follow the same iterative process.
Once a satisfactory spatial arrangement is achieved, the hospital design is
completed by the selection of suitable building components which complement the
spatial arrangement.

Example 3-6: Top-down design style

In the functional design of a hospital, the designer may begin with a "reference
model", i.e. the spatial layouts of existing hospitals of similar size and service
requirements. On the basis of past experience, spaces are allocated to various
divisions as shown schematically in Figure 3-6. The space in each division is then
divided further for various departments in the division, and all the way down the
line of the hierarchy. In every step along the way, the pertinent information of the
elements immediately below the level under consideration will be assessed in order
to provide input for making necessary adjustments at the current level if necessary.
The major drawback of the top-down design style is that the connection between
physical spaces and functions at lower levels cannot be easily anticipated.
Consequently, the new design is essentially based on the intuition and experience
of the designer rather than an objective analysis of the functions and space needs of
the facility. Its greatest attraction is its simplicity which keeps the time and cost of
design relatively low.

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Figure 3-6: A Model for Top-Down Design of a Hospital

Example 3-7: Bottom-up design style

A multi-purpose examination suite in a hospital is used as an illustration of bottom-

up design style. In Figure 3-7, the most basic elements (furniture) are first
organized into zones which make up the room. Thus the size of the room is
determined by spatial layout required to perform the desired services. Finally, the
suite is defined by the rooms which are parts of the multi-purpose examination
suite.

Figure 3-7: A Model for Bottom-up design of an Examination Suite

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3.6 Physical Structures
The structural design of complex engineering systems generally involves both
synthesis and analysis. Synthesis is an inductive process while analysis is a
deductive process. The activities in synthesis are often described as an art rather
than a science, and are regarded more akin to creativity than to knowledge. The
conception of a new structural system is by and large a matter of subjective
decision since there is no established procedure for generating innovative and
highly successful alternatives. The initial selection of a workable system from
numerous possible alternatives relies heavily on the judicious judgment of the
designer. Once a structural system is selected, it must be subjected to vigorous
analysis to insure that it can sustain the demands in its environment. In addition,
compatibility of the structural system with mechanical equipment and piping must
be assured.

For traditional types of structures such as office buildings, there are standard
systems derived from the past experience of many designers. However, in many
situations, special systems must be developed to meet the specified requirements.
The choice of materials for a structure depends not only on the suitability of
materials and their influence on the form of the structure. For example, in the
design of an airplane hangar, a steel skeleton frame may be selected because a
similar frame in reinforced concrete will limit the span of the structure owing to its
unfavorable ratio or resistance to weight. However, if a thin-shelled roof is adopted,
reinforced concrete may prove to be more suitable than steel. Thus, the interplay of
the structural forms and materials affects the selection of a structural system, which
in turn may influence the method of construction including the use of falsework.

Example 3-8: Steel frame supporting a turbo-blower [14]

The design of a structural frame supporting a turbo-blower supplying pressurized

air to a blast furnace in a steel mill can be used to illustrate the structural design
process. As shown in Figure 3-8, the turbo-blower consists of a turbine and a
blower linked to an air inlet stack. Since the vibration of the turbo-blower is a
major concern to its operation, a preliminary investigation calls for a supporting
frame which is separated from the structural frame of the building. An analysis of
the vibration characteristics of the turbo-blower indicates that the lowest mode of
vibration consists of independent vibration of the turbine shaft and the blower shaft,
with higher modes for the coupled turbo-blower system when both shafts vibrate
either in-phase or out-of-phase. Consequently, a steel frame with separate units for
the blower side and the turbine side is selected. The columns of the steel frame are
mounted on pile foundation and all joints of the steel frame are welded to reduce
the vibration levels.

Since the structural steel frame also supports a condenser, an air inlet and exhaust,
and a steam inlet and exhaust in addition to the turbo-blower, a static analysis is

74
made to size its members to support all applied loads. Then, a dynamic analysis is
conducted to determine the vibration characteristics of the system incorporating the
structural steel frame and the turbo-blower. When the limiting conditions for static
loads and natural frequencies of vibration are met, the design is accepted as
satisfactory.

Figure 3-8: Steel Frame Supporting a Turbo-Blower

Example 3-9: Multiple hierarchy descriptions of projects

In the previous section, a hierarchy of functional spaces was suggested for

describing a facility. This description is appropriate for functional design of spaces
and processes within a building, but may be inadequate as a view of the facility's
structural systems. A hierarchy suitable for this purpose might divide elements
into structural functions such as slabs, walls, frames, footings, piles or mats. Lower
levels of the hierarchy would describe individual design elements. For example,

75
frames would be made up of column, beam and diagonal groups which, in turn, are
composed of individual structural elements. These individual structural elements
comprise the limits on functional spaces such as rooms in a different hierarchical
perspective. Designers typically will initiate a view appropriate for their own
concerns, and these different hierarchical views must be synthesized to insure
consistency and adequacy of the overall design.

3.7 Geotechnical Engineering Investigation

Since construction is site specific, it is very important to investigate the subsurface
conditions which often influence the design of a facility as well as its foundation.
The uncertainty in the design is particularly acute in geotechnical engineering so
that the assignment of risks in this area should be a major concern. Since the degree
of uncertainty in a project is perceived differently by different parties involved in a
project, the assignment of unquantifiable risks arising from numerous unknowns to
the owner, engineer and contractor is inherently difficult. It is no wonder that courts
or arbitrators are often asked to distribute equitably a risk to parties who do not
perceive the same risks and do not want to assume a disproportionate share of such
risks.

Example 3-10: Design of a tie-back retaining wall [15]

This example describes the use of a tie-back retaining wall built in the 1960's when
such construction was uncommon and posed a considerable risk. The engineer
designing it and the owner were aware of the risk because of potentially extreme
financial losses from both remedial and litigation costs in the event that the
retaining wall failed and permitted a failure of the slope. But the benefits were
perceived as being worth the risk--benefits to the owner in terms of both lower cost
and shorter schedule, and benefits to the engineer in terms of professional
satisfaction in meeting the owner's needs and solving what appeared to be an
insurmountable technical problem.

The tie-back retaining wall was designed to permit a cut in a hillside to provide
additional space for the expansion of a steel-making facility. Figure 3-9 shows a
cross section of the original hillside located in an urban area. Numerous residential
dwellings were located on top of the hill which would have been prohibitively
costly or perhaps impossible to remove to permit regrading of the hillside to push
back the toe of the slope. The only realistic way of accomplishing the desired goal
was to attempt to remove the toe of the existing slope and use a tie-back retaining
wall to stabilize the slope as shown in Figure 3-10.

76
Figure 3-9: Typical Cross Section of Hillside Adjoining Site

Figure 3-10: Schematic Section of Anchored Steel Sheet Pile Retaining Wall

77
A commitment was made by both the owner and the engineer to accomplish what
was a common goal. The engineer made a commitment to design and construct the
wall in a manner which permitted a real-time evaluation of problems and the ability
to take mitigating measures throughout the construction of the wall. The owner
made a commitment to give the engineer both the professional latitude and
resources required to perform his work. A design-construct contract was negotiated
whereby the design could be modified as actual conditions were encountered
during construction. But even with all of the planning, investigation and design
efforts, there still remained a sizable risk of failure.

The wall was successfully built--not according to a pre-devised plan which went
smoothly, and not without numerous problems to be resolved as unexpected
groundwater and geological conditions were encountered. Estimated costs were
exceeded as each unexpected condition was addressed. But there were no
construction delays and their attendant costs as disputes over changed conditions
and contract terms were reconciled. There were no costs for legal fees arising from
litigation nor increased interest costs as construction stopped while disputes were
litigated. The owner paid more than was estimated, but not more than was
necessary and not as much as if he had to acquire the property at the top of the hill
to regrade the slope. In addition, the owner was able to attain the desired facility
expansion in far less time than by any other method.

As a result of the success of this experience and others, the use of tie-back retaining
walls has become a routine practice.

3.8 Construction Site Environment

While the general information about the construction site is usually available at the
planning stage of a project, it is important for the design professionals and
construction manager as well as the contractor to visit the site. Each group will be
benefited by first-hand knowledge acquired in the field.

For design professionals, an examination of the topography may focus their

attention to the layout of a facility on the site for maximum use of space in
compliance with various regulatory restrictions. In the case of industrial plants, the
production or processing design and operation often dictate the site layout. A poor
layout can cause construction problems such as inadequate space for staging,
limited access for materials and personnel, and restrictions on the use of certain
construction methods. Thus, design and construction inputs are important in the
layout of a facility.

The construction manager and the contractor must visit the site to gain some insight
in preparing or evaluating the bid package for the project. They can verify access
roads and water, electrical and other service utilities in the immediate vicinity, with
the view of finding suitable locations for erecting temporary facilities and the field

78
office. They can also observe any interferences of existing facilities with
construction and develop a plan for site security during construction.

In examining site conditions, particular attention must be paid to environmental

factors such as drainage, groundwater and the possibility of floods. Of particular
concern is the possible presence of hazardous waste materials from previous uses.
Cleaning up or controlling hazardous wastes can be extremely expensive.

Example 3-11: Groundwater Pollution from a Landfill [16]

The presence of waste deposits on a potential construction site can have substantial
impacts on the surrounding area. Under existing environmental regulations in the
United States, the responsibility for cleaning up or otherwise controlling wastes
generally resides with the owner of a facility in conjunction with any outstanding
insurance coverage.

A typical example of a waste problem is illustrated in Figure 3-11. In this figure, a

small pushover burning dump was located in a depression on a slope. The landfill
consisted of general refuse and was covered by a very sandy material. The
inevitable infiltration of water from the surface or from the groundwater into the
landfill will result in vertical or horizontal percolation of leachable ions and organic
contamination. This leachate would be odorous and potentially hazardous in water.
The pollutant would show up as seepage downhill, as pollution in surface streams,
or as pollution entering the regional groundwater.

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Figure 3-11: Cross-Section Illustration of a Landfill

Before new construction could proceed, this landfill site would have to be
controlled or removed. Typical control methods might involve:

• Surface water control measures, such as contour grading or surface sealing.

• Passive groundwater control techniques such as underground barriers
between the groundwater and the landfill.
• Plume management procedures such as pumping water from surrounding
wells.
• Chemical immobilization techniques such as applying surface seals or
chemical injections.
• Excavation and reburial of the landfill requiring the availability of an
engineered and environmentally sound landfill.

The excavation and reburial of even a small landfill site can be very expensive. For
example, the estimated reburial cost for a landfill like that shown in Figure 3-11
was in excess of $ 4 million in 1978.

3.9 Value Engineering

Value engineering may be broadly defined as an organized approach in identifying
unnecessary costs in design and construction and in soliciting or proposing
alternative design or construction technology to reduce costs without sacrificing
quality or performance requirements. It usually involves the steps of gathering
pertinent information, searching for creative ideas, evaluating the promising
alternatives, and proposing a more cost effective alternative. This approach is
usually applied at the beginning of the construction phase of the project life cycle.

The use of value engineering in the public sector of construction has been fostered
by legislation and government regulation, but the approach has not been widely
adopted in the private sector of construction. One explanation may lie in the
difference in practice of engineering design services in the public and private
sectors. In the public sector, the fee for design services is tightly monitored against
the "market price," or may even be based on the lowest bid for service. Such a
practice in setting professional fees encourages the design professionals to adopt
known and tried designs and construction technologies without giving much
thought to alternatives that are innovative but risky. Contractors are willing to
examine such alternatives when offered incentives for sharing the savings by
owners. In the private sector, the owner has the freedom to offer such incentives to
design professionals as well as the contractors without being concerned about the
appearance of favoritism in engaging professional services.

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Another source of cost savings from value engineering is the ability of contractors
to take advantage of proprietary or unusual techniques and knowledge specific to
the contractor's firm. For example, a contractor may have much more experience
with a particular method of tunneling that is not specified in the original design
and, because of this experience, the alternative method may be less expensive. In
advance of a bidding competition, a design professional does not know which
contractor will undertake the construction of a facility. Once a particular contractor
is chosen, then modifications to the construction technology or design may take
advantage of peculiar advantages of the contractor's organization.

As a final source of savings in value engineering, the contractor may offer genuine
new design or construction insights which have escaped the attention of the design
professional even if the latter is not restrained by the fee structure to explore more
alternatives. If the expertise of the contractor can be utilized, of course, the best
time to employ it is during the planning and design phase of the project life cycle.
That is why professional construction management or integrated
design/construction are often preferred by private owners.

3.10 Construction Planning

The development of a construction plan is very much analogous to the development
of a good facility design. The planner must weigh the costs and reliability of
different options while at the same time insuring technical feasibility. Construction
planning is more difficult in some ways since the building process is dynamic as
the site and the physical facility change over time as construction proceeds. On the
other hand, construction operations tend to be fairly standard from one project to
another, whereas structural or foundation details might differ considerably from
one facility to another.

Forming a good construction plan is an exceptionally challenging problem. There

are numerous possible plans available for any given project. While past experience
is a good guide to construction planning, each project is likely to have special
problems or opportunities that may require considerable ingenuity and creativity to
overcome or exploit. Unfortunately, it is quite difficult to provide direct guidance
concerning general procedures or strategies to form good plans in all
circumstances. There are some recommendations or issues that can be addressed to
describe the characteristics of good plans, but this does not necessarily tell a
planner how to discover a good plan. However, as in the design process, strategies
of decomposition in which planning is divided into subproblems and hierarchical
planning in which general activities are repeatably subdivided into more specific
tasks can be readily adopted in many cases.

From the standpoint of construction contractors or the construction divisions of

large firms, the planning process for construction projects consists of three stages
that take place between the moment in which a planner starts the plan for the

81
construction of a facility to the moment in which the evaluation of the final output
of the construction process is finished.

The estimate stage involves the development of a cost and duration estimate for the
construction of a facility as part of the proposal of a contractor to an owner. It is the
stage in which assumptions of resource commitment to the necessary activities to
build the facility are made by a planner. A careful and thorough analysis of
different conditions imposed by the construction project design and by site
characteristics are taken into consideration to determine the best estimate. The
success of a contractor depends upon this estimate, not only to obtain a job but also
to construct the facility with the highest profit. The planner has to look for the time-
cost combination that will allow the contractor to be successful in his commitment.
The result of a high estimate would be to lose the job, and the result of a low
estimate could be to win the job, but to lose money in the construction process.
When changes are done, they should improve the estimate, taking into account not
only present effects, but also future outcomes of succeeding activities. It is very
seldom the case in which the output of the construction process exactly echoes the
estimate offered to the owner.

In the monitoring and control stage of the construction process, the construction
manager has to keep constant track of both activities' durations and ongoing costs.
It is misleading to think that if the construction of the facility is on schedule or
ahead of schedule, the cost will also be on the estimate or below the estimate,
especially if several changes are made. Constant evaluation is necessary until the
construction of the facility is complete. When work is finished in the construction
process, and information about it is provided to the planner, the third stage of the
planning process can begin.

The evaluation stage is the one in which results of the construction process are
matched against the estimate. A planner deals with this uncertainty during the
estimate stage. Only when the outcome of the construction process is known is
he/she able to evaluate the validity of the estimate. It is in this last stage of the
planning process that he or she determines if the assumptions were correct. If they
were not or if new constraints emerge, he/she should introduce corresponding
adjustments in future planning.

3.11 Industrialized Construction and Pre-fabrication

Another approach to construction innovation is to apply the principles and
organizational solutions adopted for manufacturing. Industrialized construction and
pre-fabrication would involve transferring a significant portion of construction
operations from the construction site to more or less remote sites where individual
components of buildings and structures are produced. Elements of facilities could
be prefabricated off the erection site and assembled by cranes and other lifting
machinery.

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There are a wide variety and degrees of introducing greater industrialization to the
construction process. Many components of constructed facilities have always been
manufactured, such as air conditioning units. Lumber, piping and other individual
components are manufactured to standard sizes. Even temporary items such as
forms for concrete can be assembled off-site and transported for use. Reinforcing
bars for concrete can also be pre-cut and shaped to the desired configuration in a
manufacturing plant or in an automated plant located proximate to a construction
site.

A major problem in extending the use of pre-fabricated units is the lack of

standardization for systems and building regulations.[17] While designers have
long adopted standard sizes for individual components in designs, the adoption of
standardized sub-assemblies is rarer. Without standardization, the achievement of a
large market and scale economies of production in manufacturing may be
impossible. An innovative and more thorough industrialization of the entire
building process may be a primary source of construction cost savings in the future.

Example 3-12: Planning of pre-fabrication

When might pre-fabricated components be used in preference to components

assembled on a construction site? A straightforward answer is to use pre-fabricated
components whenever their cost, including transportation, is less than the cost of
assembly on site. As an example, forms for concrete panels might be transported to
a construction site with reinforcing bars already built in, necessary coatings applied
to the forms, and even special features such as electrical conduit already installed in
the form. In some cases, it might be less expensive to pre-fabricate and transport
the entire concrete panel to a manufacturing site. In contrast, traditional
construction practice would be to assemble all the different features of the panel
on-site. The relevant costs of these alternatives could be assessed during
construction planning to determine the lowest cost alternative.

In addition to the consideration of direct costs, a construction planner should also

consider some other aspects of this technology choice. First, the planner must
insure that pre-fabricated components will satisfy the relevant building
codes and regulations. Second, the relative quality of traditional versus pre-
fabricated components as experienced in the final facility should be considered.
Finally, the availability of components at the required time during the construction
process should also be considered.

Example 3-13: Impacts of building codes[18]

Building codes originated as a part of the building regulatory process for the safety
and general welfare of the public. The source of all authority to enact building
codes is based on the police power of the state which may be delegated by the state
legislature to local government units. Consequently, about 8,000 localities having

83
their own building codes, either by following a national model code or developing
a local code. The lack of uniformity of building codes may be attributed to a variety
of reasons:

• Neighboring municipalities may adopt different national models as the basis

for local regulation.
• Periodic revisions of national codes may not be adopted by local authorities
before the lapse of several years.
• Municipalities may explicitly decline to adopt specific provisions of national
model codes or may use their own variants of key provisions.
• Local authorities may differ in interpretation of the same language in
national model codes.

The lack of uniformity in building codes has serious impact on design and
construction as well as the regulatory process for buildings. Among the significant
factors are:

• Delay in the diffusion of new building innovations which may take a long
time to find their ways to be incorporated in building codes.
• Discouragement to new production organizations, such as industrialized
construction and prefabrication.
• Duplication of administrative cost of public agencies and compliance cost
incurred by private firms.

3.12 Computer-Aided Engineering

In the past twenty years, the computer has become an essential tool in engineering,
design, and accounting. The innovative designs of complicated facilities cited in the
previous sections would be impossible without the aid of computer based analysis
tools. By using general purpose analysis programs to test alternative designs of
complex structures such as petrochemical plants, engineers are able to greatly
improve initial designs. General purpose accounting systems are also available and
adopted in organizations to perform routine bookkeeping and financial accounting
chores. These applications exploit the capability for computers to perform
numerical calculations in a pre-programmed fashion rapidly, inexpensively and
accurately.

Despite these advances, the computer is often used as only an incidental tool in the
design, construction and project management processes. However, new
capabilities, systems and application programs are rapidly being adopted. These are
motivated in part by the remarkable improvement in computer hardware capability,
the introduction of the Internet, and an extraordinary decline in cost. New concepts
in computer design and in software are also contributing. For example, the
introduction of personal computers using microcircuitry has encouraged the
adoption of interactive programs because of the low cost and considerable

84
capability of the computer hardware. Personal computers available for a thousand
dollars in 1995 have essentially the same capability as expensive mainframe
computer systems of fifteen years earlier.

Computer graphics provide another pertinent example of a potentially revolutionary

mechanism for design and communication. Graphical representations of both the
physical and work activities on projects have been essential tools in the
construction industry for decades. However, manual drafting of blueprints, plans
and other diagrams is laborious and expensive. Stand alone, computer aided
drafting equipment has proved to be less expensive and fully capable of producing
the requiring drawings. More significantly, the geometric information required for
producing desired drawings might also be used as a database for computer aided
design and computer integrated construction. Components of facilities can be
represented as three dimensional computer based solid models for this purpose.
Geometric information forms only one component of integrated design databases in
which the computer can assure consistency, completeness and compliance with
relevant specifications and constraints. Several approaches to integrated computer
aided engineering environments of this type have already been attempted. [19]

Computers are also being applied more and more extensively to non-analytical and
non-numerical tasks. For example, computer based specification writing assistants
are used to rapidly assemble sets of standard specifications or to insert special
clauses in the documentation of facility designs. As another example, computerized
transfer of information provides a means to avoid laborious and error-prone
transcription of project information. While most of the traditional applications and
research in computer aids have emphasized numerical calculations, the use of
computers will rapidly shift towards the more prevalent and difficult problems of
planning, communication, design and management.

Knowledge based systems represent a prominent example of new software

approaches applicable to project management. These systems originally emerged
from research in artificial intelligence in which human cognitive processes were
modeled. In limited problem domains such as equipment configuration or process
control, knowledge based systems have been demonstrated to approach or surpass
the performance of human experts. The programs are marked by a separation
between the reasoning or "inference" engine program and the representation of
domain specific knowledge. As a result, system developers need not specify
complete problem solving strategies (or algorithms) for particular problems. This
characteristic of knowledge based systems make them particularly useful in the ill-
structured domains of design and project management. Chapter 15 will discuss
knowledge based systems in greater detail.

Computer program assistants will soon become ubiquitous in virtually all project
management organizations. The challenge for managers is to use the new tools in
an effective fashion. Computer intensive work environments should be structured

85
to aid and to amplify the capabilities of managers rather than to divert attention
from real problems such as worker motivation.

3.13 Pre-Project Planning

Even before design and construction processes begin, there is a stage of "pre-
project planning" that can be critical for project success. In this process, the project
scope is established. Since construction and design professionals are often not
involved in this project scope stage, the terminology of describing this as a "pre-
project" process has arisen. From the owner's perspective, defining the project
scope is just another phase in the process of acquiring a constructed facility.

The definition of a project scope typically involves developing project alternatives

at a conceptual level, analyzing project risks and economic payoff, developing a
financial plan, making a decision to proceed (or not), and deciding upon the project
organization and control plan. The next few chapters will examine these different
problems at some length.

The danger of poor project definition comes from escalating costs (as new items are
added) or, in the extreme, project failure. A good definition of scope allows all the
parties in the project to understand what is needed and to work towards meeting
those needs.

Example 3-14: The Project Definition Rating Index (PDRI) for Building
Projects The Construction Industry Institute has developed rating indexes for
different types of projects to assess the adequacy of project scope definitions.
[20] These are intended to reflect best practices in the building industry and
provides a checklist for recommended activities and milestones to define a project
scope. The rating index is a weighted sum of scores received for a variety of items
on the scope definition checklist. Each item in the checklist is rated as "not
applicable" (0), "complete definition" (1), "minor deficiencies" (2), "some
deficiencies" (3), "major deficiencies" (4) or "incomplete or poor definition" (5).
Lower scores in these categories are preferable. Some items in the checklist
include:

• Business Strategy for building use, justification, plan, economic analysis,

facility requirements, expansion/alteration consideration, site selection issues
and project objectives.
• Owner Philosophy with regard to reliability, maintenance, operation and
design.
• Project Requirements for value engineering, design, existing facility, scope
of work review, schedule and budget.
• Site Information including applicable regulatory reporting and permits
requirements.

86
 • Building Programming including room by room definitions for use, finishes,
interior requirements and hvac (heating, ventilating and air conditioning).
• Design Parameters including all components and a constructability analysis.
• Equipment including inventory, locations and utility requirements.

3.14 References
1. Au, T. and P. Christiano, Structural Analysis, Prentice-Hall, Inc., Englewood
Cliffs, NJ, 1987.
2. Building Research Advisory Board, Exploratory Study on Responsibility,
Liability and Accountability for Risks in Construction, National Academy of
Sciences, Washington, D.C., 1978.
3. Drucker, P.F., Innovation and Entrepreneurship: Practice and
Principles, Harper and Row, New York, 1985.
4. Gaylord, E., and C. Gaylord (Editors), Structural Engineering Handbook,
McGraw-Hill Book Co., New York, 1979.
5. Levitt, R.E., R.D. Logcher and N.H. Quaddumi, "Impact of Owner-Engineer
Risk Sharing on Design Conservatism," ASCE Journal of Professional
Issues in Engineering, Vol. 110, 1984, pp. 157-167.
6. Simon, H.A., The Science of the Artificial, Second Edition, MIT Press,
Cambridge, MA, 1981.
7. Tatum, C.B., "Innovation on the Construction Project: A Process
View," Project Management Journal, Vol. 18, No. 5, 1987, pp. 57-67.
8. Pre-Project Planning Research Team, Pre-Project Planning
Handbook Construction Industry Institute, Publication 39-2, April 1995.

3.15 Footnotes
1. See "ASCE Unveils Quality Manual", ENR, November 5, 1987, p. 14) Back
2. See V. Fairweather, "Milan's Model Metro", Civil Engineering, December
1987, pp. 40-43.Back
3. See T.Y. Lin and B.G. Gerwick, Jr. "Design of Long Span Concrete
Bridges with Special References to Prestressing, Precasting, Structural
Behavior and Economics," ACI Publication SP-23, First International
Symposium, 1969, pp. 693-704 Back
4. See Linnhoff, B., D.W. Townsend, D. Boland, G.F. Hewitt, B.E.A. Thomas,
A.R. Guy, and R.H. Marsland, User Guide on Process Integration for
the Efficient Use of Energy, Institution of Chemical Engineers, Rugby,
Warks., England, 1982. Back
5. "More Construction for the Money," Summary Report of the
Construction Industry Cost Effectiveness Project, The Business Roundtable,
New York, 1983, pg. 30. Back
6. See "The Quiet Revolution in Skyscraper Design, " Civil Engineering, May
1983, pp. 54-59. Back

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7. See J. Landis, "Why Homebuilders Don't Innovate," Built Environment, Vol.
8, No. 1, 1982, pp. 46-53. Back
8. See P.J. Cassimates, Economics of the Construction Industry, National
Industry Conference Board (SBE No. 111), 1969. Back
9. See F. Moavenzadeh, "Construction's High Technology
Revolution," Technology Review, October, 1985, pp. 32-39. Back
10. For more information on Green Buildings see the LEED website:
http://www.usgbc.org/LEED/LEED_main.asp Back
11. See R.W. Jensen and C.C. Tonies (Editors), Software Engineering, Prentice-
Hall, Inc., Englewood Cliffs, NJ, 1979, p. 22. Back
12. See S.J. Fenves, "Computer Applications," in Structural Engineering
Handbook, (Gaylord, E. and C. Gaylord, Editors), McGraw-Hill Book Co.,
New York, NY, 1979. Back
13. See T. Au, E.W. Parti and A.K.C. Wong, "Computer Applications for Health
Care Facility Design," Computers in Biology and Medicine, Vol. 1, No. 4,
1971, pp. 299-316. Back
14. The authors are indebted to E. D'Appolonia for suggesting this
example. Back
15. See E. D'Appolonia, R. Alperstein and D.J. D'Appolonia, "Behavior of
Colluvial Slope", ASCE Journal of Soil Mechanics and Foundations
Division, Vol. 93, No. SM4, 1967, pp. 447-473. Back
16. The material in this example is adapted from A.L. Tolman, A. P. Ballestero,
W.W. Beck, G.H. Emrich, "Guidance Manual for Minimizing Pollution from
Waste Disposal Sites," Report to the Municipal Environmental Research
Laboratory, U.S. Environmental Protection Agency, EPA-600/2-78-142,
August 1978. Back
17. For discussions of industrialized building, see Bender, Richard, A Crack in
the Rear View Mirror - A View of Industrialized Building, Von Nostrand
Reinhold Co., 1983; Nutt-Powell, Thomas, E., Manufactured Homes:
Making Sense of a Housing Opportunity, Auburn House, 1982; or
Warzawski, A., M. Avraham, and D. Carmel, "Utilization of Precast
Concrete Elements in Building," ASCE Journal of Construction Engineering
and Management, Vol. 110, No. CO4, 1984, pp. 476-485. Back
18. See C.G. Field and S.R. Rivkin, The Building Code Burden, Lexington
Books, D.C. Heath and Co., Lexington, MA, 1975. Back
19. See Rehak, Daniel R. and L.A. Lopez, Computer Aided Engineering
Problems and Prospects, Dept. of Civil Engineering, University of Illinois,
1981. Back
20. See PDRI for Building Projects Research Team, PDRI: Project Definition
Rating Index for Building Projects, Construction Industry Institute, Resource
155-2, July 1999.Back

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4. Labor, Material and Equipment
Utilization
4.1 Historical Perspective
Good project management in construction must vigorously pursue the efficient
utilization of labor, material and equipment. Improvement of labor productivity
should be a major and continual concern of those who are responsible for cost
control of constructed facilities. Material handling, which includes procurement,
inventory, shop fabrication and field servicing, requires special attention for cost
reduction. The use of new equipment and innovative methods has made possible
wholesale changes in construction technologies in recent decades. Organizations
which do not recognize the impact of various innovations and have not adapted to
changing environments have justifiably been forced out of the mainstream of
construction activities.

Observing the trends in construction technology presents a very mixed and

ambiguous picture. On the one hand, many of the techniques and materials used for
construction are essentially unchanged since the introduction of mechanization in
the early part of the twentieth century. For example, a history of the Panama Canal
construction from 1904 to 1914 argues that:

[T]he work could not have done any faster or more efficiently in our day, despite
all technological and mechanical advances in the time since, the reason being that
no present system could possibly carry the spoil away any faster or more efficiently
than the system employed. No motor trucks were used in the digging of the canal;
everything ran on rails. And because of the mud and rain, no other method would
have worked half so well. [1]

In contrast to this view of one large project, one may also point to the continual
change and improvements occurring in traditional materials and techniques.
Bricklaying provides a good example of such changes:

Bricklaying...is said not to have changed in thousands of years; perhaps in the

literal placing of brick on brick it has not. But masonry technology has changed a
great deal. Motorized wheelbarrows and mortar mixers, sophisticated scaffolding
systems, and forklift trucks now assist the bricklayer. New epoxy mortars give
stronger adhesion between bricks. Mortar additives and cold-weather protection
eliminate winter shutdowns. [2]

Add to this list of existing innovations the possibility of robotic bricklaying;

automated prototypes for masonry construction already exist. Technical change is

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certainly occurring in construction, although it may occur at a slower rate than in
other sectors of the economy.

The United States construction industry often points to factors which cannot be
controlled by the industry as a major explanatory factor in cost increases and lack
of technical innovation. These include the imposition of restrictions for protection
of the environment and historical districts, requirements for community
participation in major construction projects, labor laws which allow union strikes to
become a source of disruption, regulatory policies including building codes and
zoning ordinances, and tax laws which inhibit construction abroad. However, the
construction industry should bear a large share of blame for not realizing earlier
that the technological edge held by the large U.S. construction firms has eroded in
face of stiff foreign competition. Many past practices, which were tolerated when
U.S. contractors had a technological lead, must now be changed in the face of stiff
competition. Otherwise, the U.S. construction industry will continue to find itself in
trouble.

With a strong technological base, there is no reason why the construction industry
cannot catch up and reassert itself to meet competition wherever it may be.
Individual design and/or construction firms must explore new ways to improve
productivity for the future. Of course, operational planning for construction projects
is still important, but such tactical planning has limitations and may soon reach the
point of diminishing return because much that can be wrung out of the existing
practices have already been tried. What is needed the most is strategic planning to
usher in a revolution which can improve productivity by an order of magnitude or
more. Strategic planning should look at opportunities and ask whether there are
potential options along which new goals may be sought on the basis of existing
resources. No one can be certain about the success of various development options
for the design professions and the construction industry. However, with the
availability of today's high technology, some options have good potential of
success because of the social and economic necessity which will eventually push
barriers aside. Ultimately, decisions for action, not plans, will dictate future
outcomes.

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4.2 Labor Productivity

Productivity in construction is often broadly defined as output per labor hour. Since
labor constitutes a large part of the construction cost and the quantity of labor hours
in performing a task in construction is more susceptible to the influence of
management than are materials or capital, this productivity measure is often
referred to as labor productivity. However, it is important to note that labor
productivity is a measure of the overall effectiveness of an operating system in
utilizing labor, equipment and capital to convert labor efforts into useful output,

90
and is not a measure of the capabilities of labor alone. For example, by investing in
a piece of new equipment to perform certain tasks in construction, output may be
increased for the same number of labor hours, thus resulting in higher labor
productivity.

Construction output may be expressed in terms of functional units or constant

dollars. In the former case, labor productivity is associated with units of product per
labor hour, such as cubic yards of concrete placed per hour or miles of highway
paved per hour. In the latter case, labor productivity is identified with value of
construction (in constant dollars) per labor hour. The value of construction in this
regard is not measured by the benefit of constructed facilities, but by construction
cost. Labor productivity measured in this way requires considerable care in
interpretation. For example, wage rates in construction have been declining in the
US during the period 1970 to 1990, and since wages are an important component in
construction costs, the value of construction put in place per hour of work will
decline as a result, suggesting lower productivity.

Productivity at the Job Site

Contractors and owners are often concerned with the labor activity at job sites. For
this purpose, it is convenient to express labor productivity as functional units per
labor hour for each type of construction task. However, even for such specific
purposes, different levels of measure may be used. For example, cubic yards of
concrete placed per hour is a lower level of measure than miles of highway paved
per hour. Lower-level measures are more useful for monitoring individual
activities, while higher-level measures may be more convenient for developing
industry-wide standards of performance.

While each contractor or owner is free to use its own system to measure labor
productivity at a site, it is a good practice to set up a system which can be used to
track productivity trends over time and in varied locations. Considerable efforts are
required to collect information regionally or nationally over a number of years to
produce such results. The productivity indices compiled from statistical data should
include parameters such as the performance of major crafts, effects of project size,
type and location, and other major project influences.

In order to develop industry-wide standards of performance, there must be a

general agreement on the measures to be useful for compiling data. Then, the job
site productivity data collected by various contractors and owners can be correlated
and analyzed to develop certain measures for each of the major segment of the
construction industry. Thus, a contractor or owner can compare its performance
with that of the industry average.

Productivity in the Construction Industry

91
Because of the diversity of the construction industry, a single index for the entire
industry is neither meaningful nor reliable. Productivity indices may be developed
for major segments of the construction industry nationwide if reliable statistical
data can be obtained for separate industrial segments. For this general type of
productivity measure, it is more convenient to express labor productivity as
constant dollars per labor hours since dollar values are more easily aggregated from
a large amount of data collected from different sources. The use of constant dollars
allows meaningful approximations of the changes in construction output from one
year to another when price deflators are applied to current dollars to obtain the
corresponding values in constant dollars. However, since most construction price
deflators are obtained from a combination of price indices for material and labor
inputs, they reflect only the change of price levels and do not capture any savings
arising from improved labor productivity. Such deflators tend to overstate increases
in construction costs over a long period of time, and consequently understate the
physical volume or value of construction work in years subsequent to the base year
for the indices.

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4.3 Factors Affecting Job-Site Productivity

Job-site productivity is influenced by many factors which can be characterized
either as labor characteristics, project work conditions or as non-productive
activities. The labor characteristics include:

• age, skill and experience of workforce

• leadership and motivation of workforce

The project work conditions include among other factors:

• Job size and complexity.

• Job site accessibility.
• Labor availability.
• Equipment utilization.
• Contractual agreements.
• Local climate.
• Local cultural characteristics, particularly in foreign operations.

The non-productive activities associated with a project may or may not be paid by
the owner, but they nevertheless take up potential labor resources which can
otherwise be directed to the project. The non-productive activities include among
other factors:

• Indirect labor required to maintain the progress of the project

• Rework for correcting unsatisfactory work

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 • Temporary work stoppage due to inclement weather or material shortage
• Time off for union activities
• Absentee time, including late start and early quits
• Non-working holidays
• Strikes

Each category of factors affects the productive labor available to a project as well
as the on-site labor efficiency.

Labor Characteristics

Performance analysis is a common tool for assessing worker quality and

contribution. Factors that might be evaluated include:

• Quality of Work - caliber of work produced or accomplished.

• Quantity of Work - volume of acceptable work
• Job Knowledge - demonstrated knowledge of requirements, methods,
techniques and skills involved in doing the job and in applying these to
increase productivity.
• Related Work Knowledge - knowledge of effects of work upon other areas
and knowledge of related areas which have influence on assigned work.
• Judgment - soundness of conclusions, decisions and actions.
• Initiative - ability to take effective action without being told.
• Resource Utilization - ability to delineate project needs and locate, plan and
effectively use all resources available.
• Dependability - reliability in assuming and carrying out commitments and
obligations.
• Analytical Ability - effectiveness in thinking through a problem and
reaching sound conclusions.
• Communicative Ability - effectiveness in using orgal and written
communications and in keeping subordinates, associates, superiors and
others adequately informed.
• Interpersonal Skills - effectiveness in relating in an appropriate and
productive manner to others.
• Ability to Work Under Pressure - ability to meet tight deadlines and adapt to
changes.
• Security Sensitivity - ability to handle confidential information appropriately
and to exercise care in safeguarding sensitive information.
• Safety Consciousness - has knowledge of good safety practices and
demonstrates awareness of own personal safety and the safety of others.
• Profit and Cost Sensitivity - ability to seek out, generate and implement
profit-making ideas.
• Planning Effectiveness - ability to anticipate needs, forecast conditions, set
goals and standards, plan and schedule work and measure results.

93
 • Leadership - ability to develop in others the willingenss and desire to work
towards common objectives.
• Delegating - effectiveness in delegating work appropriately.
• Development People - ability to select, train and appraise personnel, set
standards of performance, and provide motivation to grow in their capacity.
< li>Diversity (Equal Employment Opportunity) - ability to be senstive to
the needs of minorities, females and other protected groups and to
demonstrate affirmative action in responding to these needs.

These different factors could each be assessed on a three point scale: (1) recognized
strength, (2) meets expectations, (3) area needing improvement. Examples of work
performance in these areas might also be provided.

Project Work Conditions

Job-site labor productivity can be estimated either for each craft (carpenter,
bricklayer, etc.) or each type of construction (residential housing, processing plant,
etc.) under a specific set of work conditions. A base labor productivity may be
defined for a set of work conditions specified by the owner or contractor who
wishes to observe and measure the labor performance over a period of time under
such conditions. A labor productivity index may then be defined as the ratio of the
job-site labor productivity under a different set of work conditions to the base labor
productivity, and is a measure of the relative labor efficiency of a project under this
new set of work conditions.

The effects of various factors related to work conditions on a new project can be
estimated in advance, some more accurately than others. For example, for very
large construction projects, the labor productivity index tends to decrease as the
project size and/or complexity increase because of logistic problems and the
"learning" that the work force must undergo before adjusting to the new
environment. Job-site accessibility often may reduce the labor productivity index if
the workers must perform their jobs in round about ways, such as avoiding traffic
in repaving the highway surface or maintaining the operation of a plant during
renovation. Labor availability in the local market is another factor. Shortage of
local labor will force the contractor to bring in non-local labor or schedule overtime
work or both. In either case, the labor efficiency will be reduced in addition to
incurring additional expenses. The degree of equipment utilization and
mechanization of a construction project clearly will have direct bearing on job-site
labor productivity. The contractual agreements play an important role in the
utilization of union or non-union labor, the use of subcontractors and the degree of
field supervision, all of which will impact job-site labor productivity. Since on-site
construction essentially involves outdoor activities, the local climate will influence
the efficiency of workers directly. In foreign operations, the cultural characteristics
of the host country should be observed in assessing the labor efficiency.

94
Non-Productive Activities

The non-productive activities associated with a project should also be examined in

order to examine the productive labor yield, which is defined as the ratio of direct
labor hours devoted to the completion of a project to the potential labor hours. The
direct labor hours are estimated on the basis of the best possible conditions at a job
site by excluding all factors which may reduce the productive labor yield. For
example, in the repaving of highway surface, the flagmen required to divert traffic
represent indirect labor which does not contribute to the labor efficiency of the
paving crew if the highway is closed to the traffic. Similarly, for large projects in
remote areas, indirect labor may be used to provide housing and infrastructure for
the workers hired to supply the direct labor for a project. The labor hours spent on
rework to correct unsatisfactory original work represent extra time taken away from
potential labor hours. The labor hours related to such activities must be deducted
from the potential labor hours in order to obtain the actual productive labor yield.

Example 4-1: Effects of job size on productivity

A contractor has established that under a set of "standard" work conditions for
building construction, a job requiring 500,000 labor hours is considered standard in
determining the base labor productivity. All other factors being the same, the labor
productivity index will increase to 1.1 or 110% for a job requiring only 400,000
labor-hours. Assuming that a linear relation exists for the range between jobs
requiring 300,000 to 700,000 labor hours as shown in Figure 4-1, determine the
labor productivity index for a new job requiring 650,000 labor hours under
otherwise the same set of work conditions.

95
Figure 4-1: Illustrative Relationship between Productivity Index and Job Size

The labor productivity index I for the new job can be obtained by linear
interpolation of the available data as follows:

This implies that labor is 15% less productive on the large job than on the standard
project.

Example 4-2: Productive labor yield [3]

In the construction of an off-shore oil drilling platform, the potential labor hours
were found to be L = 7.5 million hours. Of this total, the non-productive activities
expressed in thousand labor hours were as follows:

• A = 417 for holidays and strikes

• B = 1,415 for absentees (i.e. vacation, sick time, etc.)
• C = 1,141 for temporary stoppage (i.e. weather, waiting, union activities,
etc.)
• D = 1,431 for indirect labor (i.e. building temporary facilities, cleaning up
the site, rework to correct errors, etc.)

96
Determine the productive labor yield after the above factors are taken into
consideration.

The percentages of time allocated to various non-productive activities, A, B, C and

D are:

The total percentage of time X for all non-productive activities is:

The productive labor yield, Y, when the given factors for A, B, C and D are
considered, is as follows:

As a result, only 41% of the budgeted labor time was devoted directly to work on
the facility.

Example 4-3: Utilization of on-site worker's time

An example illustrating the effects of indirect labor requirements which limit

productive labor by a typical craftsman on the job site was given by R. Tucker with
the following percentages of time allocation: [4]

Productive time 40%

Unproductive time
Administrative delays 20%
Inefficient work methods 20%
Labor jurisdictions and other work 15%
restrictions 5%
Personal time

In this estimate, as much time is spent on productive work as on delays due to

management and inefficiencies due to antiquated work methods.

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Back to top

4.4 Labor Relations in Construction

The market demand in construction fluctuates greatly, often within short periods
and with uneven distributions among geographical regions. Even when the volume
of construction is relatively steady, some types of work may decline in importance
while other types gain. Under an unstable economic environment, employers in the
construction industry place great value on flexibility in hiring and laying off
workers as their volumes of work wax and wane. On the other hand, construction
workers sense their insecurity under such circumstances and attempt to limit the
impacts of changing economic conditions through labor organizations.

There are many crafts in the construction labor forces, but most contractors hire
from only a few of these crafts to satisfy their specialized needs. Because of the
peculiar characteristics of employment conditions, employers and workers are
placed in a more intimate relationship than in many other industries. Labor and
management arrangements in the construction industry include both unionized and
non-unionized operations which compete for future dominance. Dramatic shifts in
unionization can occur. For example, the fraction of trade union members in the
construction industry declined from 42% in 1992 to 26% in 2000 in Australia, a
40% decline in 8 years.

Unionized Construction

The craft unions work with construction contractors using unionized labor through
various market institutions such as jurisdiction rules, apprenticeship programs, and
the referral system. Craft unions with specific jurisdiction rules for different trades
set uniform hourly wage rates for journeymen and offer formal apprenticeship
training to provide common and equivalent skill for each trade. Contractors,
through the contractors' associations, enter into legally binding collective
bargaining agreements with one or more of the craft unions in the construction
trades. The system which bind both parties to a collective bargaining agreement is
referred to as the "union shop". These agreements obligate a contractor to observe
the work jurisdictions of various unions and to hire employees through a union
operated referral system commonly known as the hiring hall.

The referral systems operated by union organizations are required to observe

several conditions:

1. All qualified workers reported to the referral system must be made available
to the contractor without discrimination on the basis of union membership or
other relationship to the union. The "closed shop" which limits referral to
union members only is now illegal.

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 2. The contractor reserves the right to hire or refuse to hire any worker referred
by the union on the basis of his or her qualifications.
3. The referral plan must be posted in public, including any priorities of
referrals or required qualifications.

While these principles must prevail, referral systems operated by labor

organizations differ widely in the construction industry.

Contractors and craft unions must negotiate not only wage rates and working
conditions, but also hiring and apprentice training practices. The purpose of trade
jurisdiction is to encourage considerable investment in apprentice training on the
part of the union so that the contractor will be protected by having only qualified
workers perform the job even though such workers are not permanently attached to
the contractor and thus may have no sense of security or loyalty. The referral
system is often a rapid and dependable source of workers, particularly for a
contractor who moves into a new geographical location or starts a new project
which has high fluctuations in demand for labor. By and large, the referral system
has functioned smoothly in providing qualified workers to contractors, even though
some other aspects of union operations are not as well accepted by contractors.

Non-Unionized Construction

In recent years, non-union contractors have entered and prospered in an industry

which has a long tradition of unionization. Non-union operations in construction
are referred to as "open shops." However, in the absence of collective bargaining
agreements, many contractors operate under policies adopted by non-union
contractors' associations. This practice is referred to as "merit shop", which follows
substantially the same policies and procedures as collective bargaining although
under the control of a non-union contractors' association without union
participation. Other contractors may choose to be totally "unorganized" by not
following either union shop or merit shop practices.

The operations of the merit shop are national in scope, except for the local or state
apprenticeship and training plans. The comprehensive plans of the contractors'
association apply to all employees and crafts of a contractor regardless of their
trades. Under such operations, workers have full rights to move through the nation
among member contractors of the association. Thus, the non-union segment of the
industry is organized by contractors' associations into an integral part of the
construction industry. However, since merit shop workers are employed directly by
the construction firms, they have a greater loyalty to the firm, and recognize that
their own interest will be affected by the financial health of the firm.

Playing a significant role in the early growth and continued expansion of merit
shop construction is the Associated Builders and Contractors association. By 1987,
it had a membership of nearly 20,000 contractors and a network of 75 chapters

99
through the nation. Among the merit shop contractors are large construction firms
such as Fluor Daniel, Blount International, and Brown & Root Construction. The
advantages of merit shops as claimed by its advocates are:

• the ability to manage their own work force

• flexibility in making timely management decisions
• the emphasis on making maximum usage of local labor force
• the emphasis on encouraging individual work advancement through
continued development of skills
• the shared interest that management and workers have in seeing an
individual firm prosper.

By shouldering the training responsibility for producing skill workers, the merit
shop contractors have deflected the most serious complaints of users and labor that
used to be raised against the open shop. On the other hand, the use of mixed crews
of skilled workers at a job site by merit shop contractors enables them to remove a
major source of inefficiencies caused by the exclusive jurisdiction practiced in the
union shop, namely the idea that only members of a particular union should be
permitted to perform any given task in construction. As a result, merit shop
contractors are able to exert a beneficial influence on productivity and cost-
effectiveness of construction projects.

The unorganized form of open shop is found primarily in housing construction

where a large percentage of workers are characterized as unskilled helpers. The
skilled workers in various crafts are developed gradually through informal
apprenticeships while serving as helpers. This form of open shop is not expected to
expand beyond the type of construction projects in which highly specialized skills
are not required.

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4.5 Problems in Collective Bargaining

In the organized building trades in North American construction, the primary unit is
the international union, which is an association of local unions in the United States
and Canada. Although only the international unions have the power to issue or
remove charters and to organize or combine local unions, each local union has
considerable degrees of autonomy in the conduct of its affairs, including the
negotiation of collective bargaining agreements. The business agent of a local
union is an elected official who is the most important person in handling the day to
day operations on behalf of the union. The contractors' associations representing
the employers vary widely in composition and structure, particularly in different
geographical regions. In general, local contractors' associations are considerably
less well organized than the union with which they deal, but they try to strengthen
themselves through affiliation with state and national organizations. Typically,

100
collective bargaining agreements in construction are negotiated between a local
union in a single craft and the employers of that craft as represented by a
contractors' association, but there are many exceptions to this pattern. For example,
a contractor may remain outside the association and negotiate independently of the
union, but it usually cannot obtain a better agreement than the association.

Because of the great variety of bargaining structures in which the union and
contractors' organization may choose to stage negotiations, there are many
problems arising from jurisdictional disputes and other causes. Given the traditional
rivalries among various crafts and the ineffective organization of some of
contractors' associations, coupled with the lack of adequate mechanisms for settling
disputes, some possible solutions to these problems deserve serious attention: [5]

Regional Bargaining

Currently, the geographical area in a collective bargaining agreement does not

necessarily coincide with the territory of the union and contractors' associations in
the negotiations. There are overlapping of jurisdictions as well as territories, which
may create successions of contract termination dates for different crafts. Most
collective bargaining agreements are negotiated locally, but regional agreements
with more comprehensive coverage embracing a number of states have been
established. The role of national union negotiators and contractors' representatives
in local collective bargaining is limited. The national agreement between
international unions and a national contractor normally binds the contractors'
association and its bargaining unit. Consequently, the most promising reform lies in
the broadening of the geographic region of an agreement in a single trade without
overlapping territories or jurisdictions.

Multicraft Bargaining

The treatment of interrelationships among various craft trades in construction

presents one of the most complex issues in the collective bargaining process. Past
experience on project agreements has dealt with such issues successfully in that
collective bargaining agreements are signed by a group of craft trade unions and a
contractor for the duration of a project. Project agreements may reference other
agreements on particular points, such as wage rates and fringe benefits, but may set
their own working conditions and procedures for settling disputes including a
commitment of no-strike and no-lockout. This type of agreement may serve as a
starting point for multicraft bargaining on a regional, non-project basis.

Improvement of Bargaining Performance

Although both sides of the bargaining table are to some degree responsible for the
success or failure of negotiation, contractors have often been responsible for the
poor performance of collective bargaining in construction in recent years because

101
local contractors' associations are generally less well organized and less
professionally staffed than the unions with which they deal. Legislation providing
for contractors' association accreditation as an exclusive bargaining agent has now
been provided in several provinces in Canada. It provides a government board that
could hold hearings and establish an appropriate bargaining unit by geographic
region or sector of the industry, on a single-trade or multi-trade basis.

Back to top

4.6 Materials Management

Materials management is an important element in project planning and control.
Materials represent a major expense in construction, so
minimizing procurement or purchase costs presents important opportunities for
reducing costs. Poor materials management can also result in large and avoidable
costs during construction. First, if materials are purchased early, capital may be tied
up and interest charges incurred on the excess inventoryof materials. Even worse,
materials may deteriorate during storage or be stolen unless special care is taken.
For example, electrical equipment often must be stored in waterproof locations.
Second, delays and extra expenses may be incurred if materials required for
particular activities are not available. Accordingly, insuring a timely flow of
material is an important concern of project managers.

Materials management is not just a concern during the monitoring stage in which
construction is taking place. Decisions about material procurement may also be
required during the initial planning and scheduling stages. For example, activities
can be inserted in the project schedule to represent purchasing of major items such
as elevators for buildings. The availability of materials may greatly influence the
schedule in projects with a fast track or very tight time schedule: sufficient time for
obtaining the necessary materials must be allowed. In some case, more expensive
suppliers or shippers may be employed to save time.

Materials management is also a problem at the organization level if central

purchasing and inventory control is used for standard items. In this case, the
various projects undertaken by the organization would present requests to the
central purchasing group. In turn, this group would maintain inventories of standard
items to reduce the delay in providing material or to obtain lower costs due to bulk
purchasing. This organizational materials management problem is analogous to
inventory control in any organization facing continuing demand for particular
items.

Materials ordering problems lend themselves particularly well to computer based

systems to insure the consistency and completeness of the purchasing process. In
the manufacturing realm, the use of automated materials requirements
planning systems is common. In these systems, the master production schedule,

102
inventory records and product component lists are merged to determine what items
must be ordered, when they should be ordered, and how much of each item should
be ordered in each time period. The heart of these calculations is simple arithmetic:
the projected demand for each material item in each period is subtracted from the
available inventory. When the inventory becomes too low, a new order is
recommended. For items that are non-standard or not kept in inventory, the
calculation is even simpler since no inventory must be considered. With a materials
requirement system, much of the detailed record keeping is automated and project
managers are alerted to purchasing requirements.

Example 4-4: Examples of benefits for materials management systems.[6]

From a study of twenty heavy construction sites, the following benefits from the
introduction of materials management systems were noted:

• In one project, a 6% reduction in craft labor costs occurred due to the

improved availability of materials as needed on site. On other projects, an
8% savings due to reduced delay for materials was estimated.
• A comparison of two projects with and without a materials management
system revealed a change in productivity from 1.92 man-hours per unit
without a system to 1.14 man-hours per unit with a new system. Again,
much of this difference can be attributed to the timely availability of
materials.
• Warehouse costs were found to decrease 50% on one project with the
introduction of improved inventory management, representing a savings of $
92,000. Interest charges for inventory also declined, with one project
reporting a cash flow savings of $ 85,000 from improved materials
management.

Against these various benefits, the costs of acquiring and maintaining a materials
management system has to be compared. However, management studies suggest
that investment in such systems can be quite beneficial.

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4.7 Material Procurement and Delivery

The main sources of information for feedback and control of material procurement
are requisitions, bids and quotations, purchase orders and subcontracts, shipping
and receiving documents, and invoices. For projects involving the large scale use of
critical resources, the owner may initiate the procurement procedure even before
the selection of a constructor in order to avoid shortages and delays. Under ordinary
circumstances, the constructor will handle the procurement to shop for materials
with the best price/performance characteristics specified by the designer. Some

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overlapping and rehandling in the procurement process is unavoidable, but it
should be minimized to insure timely delivery of the materials in good condition.

The materials for delivery to and from a construction site may be broadly classified
as : (1) bulk materials, (2) standard off-the-shelf materials, and (3) fabricated
members or units. The process of delivery, including transportation, field storage
and installation will be different for these classes of materials. The equipment
needed to handle and haul these classes of materials will also be different.

Bulk materials refer to materials in their natural or semi-processed state, such as

earthwork to be excavated, wet concrete mix, etc. which are usually encountered in
large quantities in construction. Some bulk materials such as earthwork or gravels
may be measured in bank (solid in situ) volume. Obviously, the quantities of
materials for delivery may be substantially different when expressed in different
measures of volume, depending on the characteristics of such materials.

Standard piping and valves are typical examples of standard off-the-shelf materials
which are used extensively in the chemical processing industry. Since standard off-
the-shelf materials can easily be stockpiled, the delivery process is relatively
simple.

Fabricated members such as steel beams and columns for buildings are pre-
processed in a shop to simplify the field erection procedures. Welded or bolted
connections are attached partially to the members which are cut to precise
dimensions for adequate fit. Similarly, steel tanks and pressure vessels are often
partly or fully fabricated before shipping to the field. In general, if the work can be
done in the shop where working conditions can better be controlled, it is advisable
to do so, provided that the fabricated members or units can be shipped to the
construction site in a satisfactory manner at a reasonable cost.

As a further step to simplify field assembly, an entire wall panel including

plumbing and wiring or even an entire room may be prefabricated and shipped to
the site. While the field labor is greatly reduced in such cases, "materials" for
delivery are in fact manufactured products with value added by another type of
labor. With modern means of transporting construction materials and fabricated
units, the percentages of costs on direct labor and materials for a project may
change if more prefabricated units are introduced in the construction process.

In the construction industry, materials used by a specific craft are generally handled
by craftsmen, not by general labor. Thus, electricians handle electrical materials,
pipefitters handle pipe materials, etc. This multiple handling diverts scarce skilled
craftsmen and contractor supervision into activities which do not directly contribute
to construction. Since contractors are not normally in the freight business, they do
not perform the tasks of freight delivery efficiently. All these factors tend to
exacerbate the problems of freight delivery for very large projects.

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Example 4-5: Freight delivery for the Alaska Pipeline Project [7]

The freight delivery system for the Alaska pipeline project was set up to handle
600,000 tons of materials and supplies. This tonnage did not include the pipes
which comprised another 500,000 tons and were shipped through a different
routing system.

The complexity of this delivery system is illustrated in Figure 4-2. The rectangular
boxes denote geographical locations. The points of origin represent plants and
factories throughout the US and elsewhere. Some of the materials went to a
primary staging point in Seattle and some went directly to Alaska. There were five
ports of entry: Valdez, Anchorage, Whittier, Seward and Prudhoe Bay. There was a
secondary staging area in Fairbanks and the pipeline itself was divided into six
sections. Beyond the Yukon River, there was nothing available but a dirt road for
hauling. The amounts of freight in thousands of tons shipped to and from various
locations are indicated by the numbers near the network branches (with arrows
showing the directions of material flows) and the modes of transportation are noted
above the branches. In each of the locations, the contractor had supervision and
construction labor to identify materials, unload from transport, determine where the
material was going, repackage if required to split shipments, and then re-load
material on outgoing transport.

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Figure 4-2: Freight Delivery for the Alaska Pipeline Project

Example 4-6: Process plant equipment procurement [8]

The procurement and delivery of bulk materials items such as piping electrical and
structural elements involves a series of activities if such items are not standard
and/or in stock. The times required for various activities in the procurement of such
items might be estimated to be as follows:

Duration Cumulative
Activities
(days) Duration
Requisition ready by designer 0 0

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Owner approval 5 5
Inquiry issued to vendors 3 8
Vendor quotations received 15 23
Complete bid evaluation by designer 7 30
Owner approval 5 35
Place purchase order 5 40
Receive preliminary shop drawings 10 50
Receive final design drawings 10 60
Fabrication and delivery 60-200 120-260

As a result, this type of equipment procurement will typically require four to nine
months. Slippage or contraction in this standard schedule is also possible, based on
such factors as the extent to which a fabricator is busy.

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4.8 Inventory Control

Once goods are purchased, they represent an inventory used during the construction
process. The general objective of inventory control is to minimize the total cost of
keeping the inventory while making tradeoffs among the major categories of costs:
(1) purchase costs, (2) order cost, (3) holding costs, and (4) unavailable cost. These
cost categories are interrelated since reducing cost in one category may increase
cost in others. The costs in all categories generally are subject to considerable
uncertainty.

Purchase Costs

The purchase cost of an item is the unit purchase price from an external source
including transportation and freight costs. For construction materials, it is common
to receive discounts for bulk purchases, so the unit purchase cost declines as
quantity increases. These reductions may reflect manufacturers' marketing policies,
economies of scale in the material production, or scale economies in transportation.
There are also advantages in having homogeneous materials. For example, a bulk
order to insure the same color or size of items such as bricks may be desirable.
Accordingly, it is usually desirable to make a limited number of large purchases for
materials. In some cases, organizations may consolidate small orders from a
number of different projects to capture such bulk discounts; this is a basic saving to
be derived from a central purchasing office.

The cost of materials is based on prices obtained through effective bargaining. Unit
prices of materials depend on bargaining leverage, quantities and delivery time.
Organizations with potential for long-term purchase volume can command better
bargaining leverage. While orders in large quantities may result in lower unit
prices, they may also increase holding costs and thus cause problems in cash flow.
Requirements of short delivery time can also adversely affect unit prices.

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Furthermore, design characteristics which include items of odd sizes or shapes
should be avoided. Since such items normally are not available in the standard
stockpile, purchasing them causes higher prices.

The transportation costs are affected by shipment sizes and other factors. Shipment
by the full load of a carrier often reduces prices and assures quicker delivery, as the
carrier can travel from the origin to the destination of the full load without having
to stop for delivering part of the cargo at other stations. Avoiding transshipment is
another consideration in reducing shipping cost. While the reduction in shipping
costs is a major objective, the requirements of delicate handling of some items may
favor a more expensive mode of transportation to avoid breakage and replacement
costs.

Order Cost

The order cost reflects the administrative expense of issuing a purchase order to an
outside supplier. Order costs include expenses of making requisitions, analyzing
alternative vendors, writing purchase orders, receiving materials, inspecting
materials, checking on orders, and maintaining records of the entire process. Order
costs are usually only a small portion of total costs for material management in
construction projects, although ordering may require substantial time.

Holding Costs

The holding costs or carrying costs are primarily the result of capital costs,
handling, storage, obsolescence, shrinkage and deterioration. Capital cost results
from the opportunity cost or financial expense of capital tied up in inventory. Once
payment for goods is made, borrowing costs are incurred or capital must be
diverted from other productive uses. Consequently, a capital carrying cost is
incurred equal to the value of the inventory during a period multiplied by the
interest rate obtainable or paid during that period. Note that capital costs only
accumulate when payment for materials actually occurs; many organizations
attempt to delay payments as long as possible to minimize such costs. Handling and
storage represent the movement and protection charges incurred for materials.
Storage costs also include the disruption caused to other project activities by large
inventories of materials that get in the way. Obsolescence is the risk that an item
will lose value because of changes in specifications. Shrinkage is the decrease in
inventory over time due to theft or loss. Deterioration reflects a change in material
quality due to age or environmental degradation. Many of these holding
cost components are difficult to predict in advance; a project manager knows only
that there is some chance that specific categories of cost will occur. In addition to
these major categories of cost, there may be ancillary costs of additional insurance,
taxes (many states treat inventories as taxable property), or additional fire hazards.
As a general rule, holding costs will typically represent 20 to 40% of the average
inventory value over the course of a year; thus if the average material inventory on

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a project is $ 1 million over a year, the holding cost might be expected to be
$200,000 to $400,000.

Unavailability Cost

The unavailability cost is incurred when a desired material is not available at the
desired time. In manufacturing industries, this cost is often called
the stockout or depletion cost. Shortages may delay work, thereby wasting labor
resources or delaying the completion of the entire project. Again, it may be difficult
to forecast in advance exactly when an item may be required or when an shipment
will be received. While the project schedule gives one estimate, deviations from the
schedule may occur during construction. Moreover, the cost associated with a
shortage may also be difficult to assess; if the material used for one activity is not
available, it may be possible to assign workers to other activities and, depending
upon which activities are critical, the project may not be delayed.

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4.9 Tradeoffs of Costs in Materials Management.

To illustrate the type of trade-offs encountered in materials management, suppose
that a particular item is to be ordered for a project. The amount of time required for
processing the order and shipping the item is uncertain. Consequently, the project
manager must decide how much lead time to provide in ordering the item. Ordering
early and thereby providing a long lead time will increase the chance that the item
is available when needed, but it increases the costs of inventory and the chance of
spoilage on site.

Let T be the time for the delivery of a particular item, R be the time required for
process the order, and S be the shipping time. Then, the minimum amount of time
for the delivery of the item is T = R + S. In general, both R and S are random
variables; hence T is also a random variable. For the sake of simplicity, we shall
consider only the case of instant processing for an order, i.e. R = 0. Then, the
delivery time T equals the shipping time S.

Since T is a random variable, the chance that an item will be delivered on day t is
represented by the probability p(t). Then, the probability that the item will be
delivered on or before t day is given by:

4.1

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If a and b are the lower and upper bounds of possible delivery dates, the expected
delivery time is then given by:

4.2

The lead time L for ordering an item is the time period ahead of the delivery time,
and will depend on the tradeoff between holding costs and unavailability costs. A
project manager may want to avoid the unavailable cost by requiring delivery on
the scheduled date of use, or may be to lower the holding cost by adopting a more
flexible lead time based on the expected delivery time. For example, the manager
may make the tradeoff by specifying the lead time to be D days more than the
expected delivery time, i.e.,

4.3

where D may vary from 0 to the number of additional days required to produce
certain delivery on the desired date.

In a more realistic situation, the project manager would also contend with the
uncertainty of exactly when the item might be required. Even if the item
is scheduled for use on a particular date, the work progress might vary so that the
desired date would differ. In many cases, greater than expected work progress may
result in no savings because materials for future activities are unavailable.

Example 4-7: : Lead time for ordering with no processing time.

Table 4-1 summarizes the probability of different delivery times for an item. In this
table, the first column lists the possible shipping times (ranging from 10 to 16
days), the second column lists the probability or chance that this shipping time will
occur and the third column summarizes the chance that the item arrives on or
before a particular date. This table can be used to indicate the chance that the item
will arrive on a desired date for different lead times. For example, if the order is
placed 12 days in advance of the desired date (so the lead time is 12 days), then
there is a 15% chance that the item will arrive exactly on the desired day and a 35%
chance that the item will arrive on or before the desired date. Note that this implies
that there is a 1 - 0.35 = 0.65 or 65% chance that the item will not arrive by the
desired date with a lead time of 12 days. Given the information in Table 4-1, when
should the item order be placed?

Table 4-1 Delivery Date on Orders and Probability of

Delivery for an Example
Delivery Probability ofCummulative

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 probability
Date delivery on date tof delivery by day t
t p(t)
Pr{T t}
10 0.10 0.10
11 0.10 0.20
12 0.15 0.35
13 0.20 0.55
14 0.30 0.85
15 0.10 0.95
16 0.05 1.00

Suppose that the scheduled date of use for the item is in 16 days. To be completely
certain to have delivery by the desired day, the order should be placed 16 days in
advance. However, the expected delivery date with a 16 day lead time would be:

= (10)(0.1) + (11)(0.1) + (12)(0.15) + (13)(0.20) + (14)(0.30) + (15)(0.10) + (16)

(0.05) = 13.0

Thus, the actual delivery date may be 16-13 = 3 days early, and this early delivery
might involve significant holding costs. A project manager might then decide to
provide a lead time so that the expecteddelivery date was equal to the desired
assembly date as long as the availability of the item was not critical. Alternatively,
the project manager might negotiate a more certain delivery date from the supplier.

Back to top

4.10 Construction Equipment

The selection of the appropriate type and size of construction equipment often
affects the required amount of time and effort and thus the job-site productivity of a
project. It is therefore important for site managers and construction planners to be
familiar with the characteristics of the major types of equipment most commonly
used in construction. [9]

Excavation and Loading

One family of construction machines used for excavation is broadly classified as

a crane-shovel as indicated by the variety of machines in Figure 4-3. The crane-
shovel consists of three major components:

• a carrier or mounting which provides mobility and stability for the machine.
• a revolving deck or turntable which contains the power and control units.
• a front end attachment which serves the special functions in an operation.

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The type of mounting for all machines in Figure 4-3 is referred to as crawler
mounting, which is particularly suitable for crawling over relatively rugged
surfaces at a job site. Other types of mounting include truck mounting and wheel
mounting which provide greater mobility between job sites, but require better
surfaces for their operation. The revolving deck includes a cab to house the person
operating the mounting and/or the revolving deck. The types of front end
attachments in Figure 4-3 might include a crane with hook, claim shell, dragline,
backhoe, shovel and piledriver.

Figure 4-3 Typical Machines in the Crane-Shovel Family

A tractor consists of a crawler mounting and a non-revolving cab. When an earth

moving blade is attached to the front end of a tractor, the assembly is called a
bulldozer. When a bucket is attached to its front end, the assembly is known as a

112
loader or bucket loader. There are different types of loaders designed to handle
most efficiently materials of different weights and moisture contents.

Scrapers are multiple-units of tractor-truck and blade-bucket assemblies with

various combinations to facilitate the loading and hauling of earthwork. Major
types of scrapers include single engine two-axle or three axle scrapers, twin-engine
all-wheel-drive scrapers, elevating scrapers, and push-pull scrapers. Each type has
different characteristics of rolling resistance, maneuverability stability, and speed in
operation.

Compaction and Grading

The function of compaction equipment is to produce higher density in soil

mechanically. The basic forces used in compaction are static weight, kneading,
impact and vibration. The degree of compaction that may be achieved depends on
the properties of soil, its moisture content, the thickness of the soil layer for
compaction and the method of compaction. Some major types of compaction
equipment are shown in Figure 4-4, which includes rollers with different operating
characteristics.

The function of grading equipment is to bring the earthwork to the desired shape
and elevation. Major types of grading equipment include motor graders and grade
trimmers. The former is an all-purpose machine for grading and surface finishing,
while the latter is used for heavy construction because of its higher operating speed.

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114
115
Figure 4-4 Some Major Types of Compaction Equipment

Drilling and Blasting

Rock excavation is an audacious task requiring special equipment and methods.

The degree of difficulty depends on physical characteristics of the rock type to be
excavated, such as grain size, planes of weakness, weathering, brittleness and
hardness. The task of rock excavation includes loosening, loading, hauling and
compacting. The loosening operation is specialized for rock excavation and is
performed by drilling, blasting or ripping.

Major types of drilling equipment are percussion drills, rotary drills, and rotary-
percussion drills. A percussion drill penetrates and cuts rock by impact while it
rotates without cutting on the upstroke. Common types of percussion drills include
a jackhammer which is hand-held and others which are mounted on a fixed frame
or on a wagon or crawl for mobility. A rotary drill cuts by turning a bit against the
rock surface. A rotary-percussion drill combines the two cutting movements to
provide a faster penetration in rock.

Blasting requires the use of explosives, the most common of which is dynamite.
Generally, electric blasting caps are connected in a circuit with insulated wires.
Power sources may be power lines or blasting machines designed for firing electric
cap circuits. Also available are non-electrical blasting systems which combine the
precise timing and flexibility of electric blasting and the safety of non-electrical
detonation.

Tractor-mounted rippers are capable of penetrating and prying loose most rock
types. The blade or ripper is connected to an adjustable shank which controls the
angle at the tip of the blade as it is raised or lowered. Automated ripper control may
be installed to control ripping depth and tip angle.

In rock tunneling, special tunnel machines equipped with multiple cutter heads and
capable of excavating full diameter of the tunnel are now available. Their use has
increasingly replaced the traditional methods of drilling and blasting.

Lifting and Erecting

Derricks are commonly used to lift equipment of materials in industrial or building

construction. A derrick consists of a vertical mast and an inclined boom sprouting
from the foot of the mast. The mast is held in position by guys or stifflegs
connected to a base while a topping lift links the top of the mast and the top of the
inclined boom. A hook in the road line hanging from the top of the inclined boom
is used to lift loads. Guy derricks may easily be moved from one floor to the next in

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a building under construction while stiffleg derricks may be mounted on tracks for
movement within a work area.

Tower cranes are used to lift loads to great heights and to facilitate the erection of
steel building frames. Horizon boom type tower cranes are most common in
highrise building construction. Inclined boom type tower cranes are also used for
erecting steel structures.

Mixing and Paving

Basic types of equipment for paving include machines for dispensing concrete and
bituminous materials for pavement surfaces. Concrete mixers may also be used to
mix portland cement, sand, gravel and water in batches for other types of
construction other than paving.

A truck mixer refers to a concrete mixer mounted on a truck which is capable of

transporting ready mixed concrete from a central batch plant to construction sites.
A paving mixer is a self propelled concrete mixer equipped with a boom and a
bucket to place concrete at any desired point within a roadway. It can be used as a
stationary mixer or used to supply slipform pavers that are capable of spreading,
consolidating and finishing a concrete slab without the use of forms.

A bituminous distributor is a truck-mounted plant for generating liquid bituminous

materials and applying them to road surfaces through a spray bar connected to the
end of the truck. Bituminous materials include both asphalt and tar which have
similar properties except that tar is not soluble in petroleum products. While asphalt
is most frequently used for road surfacing, tar is used when the pavement is likely
to be heavily exposed to petroleum spills.

Construction Tools and Other Equipment

Air compressors and pumps are widely used as the power sources for construction
tools and equipment. Common pneumatic construction tools include drills,
hammers, grinders, saws, wrenches, staple guns, sandblasting guns, and concrete
vibrators. Pumps are used to supply water or to dewater at construction sites and to
provide water jets for some types of construction.

Automation of Equipment

The introduction of new mechanized equipment in construction has had a profound

effect on the cost and productivity of construction as well as the methods used for
construction itself. An exciting example of innovation in this regard is the
introduction of computer microprocessors on tools and equipment. As a result, the
performance and activity of equipment can be continually monitored and adjusted
for improvement. In many cases, automation of at least part of the construction

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process is possible and desirable. For example, wrenches that automatically
monitor the elongation of bolts and the applied torque can be programmed to
achieve the best bolt tightness. On grading projects, laser controlled scrapers can
produce desired cuts faster and more precisely than wholly manual
methods. [10] Possibilities for automation and robotics in construction are explored
more fully in Chapter 16.

Example 4-8: Tunneling Equipment [11]

In the mid-1980's, some Japanese firms were successful in obtaining construction

contracts for tunneling in the United States by using new equipment and methods.
For example, the Japanese firm of Ohbayashi won the sewer contract in San
Francisco because of its advanced tunneling technology. When a tunnel is dug
through soft earth, as in San Francisco, it must be maintained at a few atmospheres
of pressure to keep it from caving in. Workers must spend several hours in a
pressure chamber before entering the tunnel and several more in decompression
afterwards. They can stay inside for only three or four hours, always at
considerable risk from cave-ins and asphyxiation. Ohbayashi used the new
Japanese "earth-pressure-balance" method, which eliminates these problems.
Whirling blades advance slowly, cutting the tunnel. The loose earth temporarily
remains behind to balance the pressure of the compact earth on all sides.
Meanwhile, prefabricated concrete segments are inserted and joined with
waterproof seals to line the tunnel. Then the loose earth is conveyed away. This
new tunneling method enabled Ohbayashi to bid $5 million below the engineer's
estimate for a San Francisco sewer. The firm completed the tunnel three months
ahead of schedule. In effect, an innovation involving new technology and method
led to considerable cost and time savings.

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4.11 Choice of Equipment and Standard Production Rates

Typically, construction equipment is used to perform essentially repetitive
operations, and can be broadly classified according to two basic functions: (1)
operators such as cranes, graders, etc. which stay within the confines of the
construction site, and (2) haulers such as dump trucks, ready mixed concrete truck,
etc. which transport materials to and from the site. In both cases, the cycle of a
piece of equipment is a sequence of tasks which is repeated to produce a unit of
output. For example, the sequence of tasks for a crane might be to fit and install a
wall panel (or a package of eight wall panels) on the side of a building; similarly,
the sequence of tasks of a ready mixed concrete truck might be to load, haul and
unload two cubic yards (or one truck load) of fresh concrete.

In order to increase job-site productivity, it is beneficial to select equipment with

proper characteristics and a size most suitable for the work conditions at a

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construction site. In excavation for building construction, for examples, factors that
could affect the selection of excavators include:

1. Size of the job: Larger volumes of excavation will require larger excavators,
or smaller excavators in greater number.
2. Activity time constraints: Shortage of time for excavation may force
contractors to increase the size or numbers of equipment for activities related
to excavation.
3. Availability of equipment: Productivity of excavation activities will
diminish if the equipment used to perform them is available but not the most
adequate.
4. Cost of transportation of equipment: This cost depends on the size of the
job, the distance of transportation, and the means of transportation.
5. Type of excavation: Principal types of excavation in building projects are
cut and/or fill, excavation massive, and excavation for the elements of
foundation. The most adequate equipment to perform one of these activities
is not the most adequate to perform the others.
6. Soil characteristics: The type and condition of the soil is important when
choosing the most adequate equipment since each piece of equipment has
different outputs for different soils. Moreover, one excavation pit could have
different soils at different stratums.
7. Geometric characteristics of elements to be excavated: Functional
characteristics of different types of equipment makes such considerations
necessary.
8. Space constraints: The performance of equipment is influenced by the
spatial limitations for the movement of excavators.
9. Characteristics of haul units: The size of an excavator will depend on the
haul units if there is a constraint on the size and/or number of these units.
10. Location of dumping areas: The distance between the construction site and
dumping areas could be relevant not only for selecting the type and number
of haulers, but also the type of excavators.
11. Weather and temperature: Rain, snow and severe temperature conditions
affect the job-site productivity of labor and equipment.

By comparing various types of machines for excavation, for example, power

shovels are generally found to be the most suitable for excavating from a level
surface and for attacking an existing digging surface or one created by the power
shovel; furthermore, they have the capability of placing the excavated material
directly onto the haulers. Another alternative is to use bulldozers for excavation.

The choice of the type and size of haulers is based on the consideration that the
number of haulers selected must be capable of disposing of the excavated materials
expeditiously. Factors which affect this selection include:

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 1. Output of excavators: The size and characteristics of the excavators
selected will determine the output volume excavated per day.
2. Distance to dump site: Sometimes part of the excavated materials may be
piled up in a corner at the job-site for use as backfill.
3. Probable average speed: The average speed of the haulers to and from the
dumping site will determine the cycle time for each hauling trip.
4. Volume of excavated materials: The volume of excavated materials
including the part to be piled up should be hauled away as soon as possible.
5. Spatial and weight constraints: The size and weight of the haulers must be
feasible at the job site and over the route from the construction site to the
dumping area.

Dump trucks are usually used as haulers for excavated materials as they can move
freely with relatively high speeds on city streets as well as on highways.

The cycle capacity C of a piece of equipment is defined as the number of output

units per cycle of operation under standard work conditions. The capacity is a
function of the output units used in the measurement as well as the size of the
equipment and the material to be processed. The cycle time T refers to units of time
per cycle of operation. The standard production rate R of a piece of construction
equipment is defined as the number of output units per unit time. Hence:

4.4

or
4.5

The daily standard production rate Pe of an excavator can be obtained by

multiplying its standard production rate Re by the number of operating hours He per
day. Thus:

4.6

where Ce and Te are cycle capacity (in units of volume) and cycle time (in hours) of
the excavator respectively.

In determining the daily standard production rate of a hauler, it is necessary to

determine first the cycle time from the distance D to a dump site and the average
speed S of the hauler. Let Tt be the travel time for the round trip to the dump site,
To be the loading time and Td be the dumping time. Then the travel time for the
round trip is given by:

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4.7

The loading time is related to the cycle time of the excavator Te and the relative
capacities Ch and Ce of the hauler and the excavator respectively. In the optimum or
standard case:

4.8

For a given dumping time Td, the cycle time Th of the hauler is given by:

4.9

The daily standard production rate Ph of a hauler can be obtained by multiplying its
standard production rate Rh by the number of operating hours Hh per day. Hence:

4.10

This expression assumes that haulers begin loading as soon as they return from the
dump site.

The number of haulers required is also of interest. Let w denote the swell factor of
the soil such that wPe denotes the daily volume of loose excavated materials
resulting from the excavation volume Pe. Then the approximate number of haulers
required to dispose of the excavated materials is given by:

4.11

While the standard production rate of a piece of equipment is based on "standard"

or ideal conditions, equipment productivities at job sites are influenced by actual
work conditions and a variety of inefficiencies and work stoppages. As one
example, various factor adjustments can be used to account in a approximate
fashion for actual site conditions. If the conditions that lower the standard
production rate are denoted by n factors F1, F2, ..., Fn, each of which is smaller than
1, then the actual equipment productivity R' at the job site can be related to the
standard production rate R as follows:

4.12

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On the other hand, the cycle time T' at the job site will be increased by these
factors, reflecting actual work conditions. If only these factors are involved, T' is
related to the standard cycle time T as:

4.13

Each of these various adjustment factors must be determined from experience or

observation of job sites. For example, a bulk composition factor is derived for bulk
excavation in building construction because the standard production rate for general
bulk excavation is reduced when an excavator is used to create a ramp to reach the
bottom of the bulk and to open up a space in the bulk to accommodate the hauler.

In addition to the problem of estimating the various factors, F 1, F2, ..., Fn, it may
also be important to account for interactions among the factors and the exact
influence of particular site characteristics.

Example 4-9: Daily standard production rate of a power shovel [12]

A power shovel with a dipper of one cubic yard capacity has a standard operating
cycle time of 30 seconds. Find the daily standard production rate of the shovel.

For Ce = 1 cu. yd., Te = 30 sec. and He = 8 hours, the daily standard production rate
is found from Eq. (4.6) as follows:

In practice, of course, this standard rate would be modified to reflect various

production inefficiencies, as described in Example 4-11.

Example 4-10: Daily standard production rate of a dump truck

A dump truck with a capacity of 6 cubic yards is used to dispose of excavated

materials at a dump site 4 miles away. The average speed of the dump truck is 30
mph and the dumping time is 30 seconds. Find the daily standard production rate of
the truck. If a fleet of dump trucks of this capacity is used to dispose of the
excavated materials in Example 4-9 for 8 hours per day, determine the number of
trucks needed daily, assuming a swell factor of 1.1 for the soil.

The daily standard production rate of a dump truck can be obtained by using
Equations (4.7) through (4.10):

122
Hence, the daily hauler productivity is:

Finally, from Equation (4.12), the number of trucks required is:

implying that 8 trucks should be used.

Example 4-11: Job site productivity of a power shovel

A power shovel with a dipper of one cubic yard capacity (in Example 4-9) has a
standard production rate of 960 cubic yards for an 8-hour day. Determine the job
site productivity and the actual cycle time of this shovel under the work conditions
at the site that affects its productivity as shown below:

Factor
Work Conditions at the Site
s
Bulk composition 0.954
Soil properties and water content 0.983
Equipment idle time for worker breaks 0.8
Management efficiency 0.7

Using Equation (4.11), the job site productivity of the power shovel per day is
given by:

123
The actual cycle time can be determined as follows:

Noting Equation (4.6), the actual cycle time can also be obtained from the relation
T'e = (CeHe)/P'e. Thus:

Example 4-12: Job site productivity of a dump truck

A dump truck with a capacity of 6 cubic yards (in Example 4-10) is used to dispose
of excavated materials. The distance from the dump site is 4 miles and the average
speed of the dump truck is 30 mph. The job site productivity of the power shovel
per day (in Example 4-11) is 504 cubic yards, which will be modified by a swell
factor of 1.1. The only factors affecting the job site productivity of the dump truck
in addition to those affecting the power shovel are 0.80 for equipment idle time and
0.70 for management efficiency. Determine the job site productivity of the dump
truck. If a fleet of such trucks is used to haul the excavated material, find the
number of trucks needed daily.

The actual cycle time T'h of the dump truck can be obtained by summing the actual
times for traveling, loading and dumping:

Hence, the actual cycle time is:

The jobsite productivity P'h of the dump truck per day is:

124
The number of trucks needed daily is:

so 8 trucks are required.

Back to top

4.12 Construction Processes

The previous sections described the primary inputs of labor, material and
equipment to the construction process. At varying levels of detail, a project
manager must insure that these inputs are effectively coordinated to achieve an
efficient construction process. This coordination involves both strategic decisions
and tactical management in the field. For example, strategic decisions about
appropriate technologies or site layout are often made during the process of
construction planning. During the course of construction, foremen and site
managers will make decisions about work to be undertaken at particular times of
the day based upon the availability of the necessary resources of labor, materials
and equipment. Without coordination among these necessary inputs, the
construction process will be inefficient or stop altogether.

Example 4-13: Steel erection

Erection of structural steel for buildings, bridges or other facilities is an example of

a construction process requiring considerable coordination. Fabricated steel pieces
must arrive on site in the correct order and quantity for the planned effort during a
day. Crews of steelworkers must be available to fit pieces together, bolt joints, and
perform any necessary welding. Cranes and crane operators may be required to lift
fabricated components into place; other activities on a job site may also be
competing for use of particular cranes. Welding equipment, wrenches and other
hand tools must be readily available. Finally, ancillary materials such as bolts of the
correct size must be provided.

In coordinating a process such as steel erection, it is common to assign different

tasks to specific crews. For example, one crew may place members in place and
insert a few bolts in joints in a specific area. A following crew would be assigned to
finish bolting, and a third crew might perform necessary welds or attachment of
brackets for items such as curtain walls.

125
With the required coordination among these resources, it is easy to see how poor
management or other problems can result in considerable inefficiency. For
example, if a shipment of fabricated steel is improperly prepared, the crews and
equipment on site may have to wait for new deliveries.

Example 4-14: Construction process simulation models

Computer based simulation of construction operations can be a useful although

laborious tool in analyzing the efficiency of particular processes or technologies.
These tools tend to be either oriented toward modeling resource processes or
towards representation of spatial constraints and resource movements. Later
chapters will describe simulation in more detail, but a small example of a
construction operation model can be described here. [13] The process involved
placing concrete within existing formwork for the columns of a new structure. A
crane-and-bucket combination with one cubic yard capacity and a flexible
"elephant trunk" was assumed for placement. Concrete was delivered in trucks with
a capacity of eight cubic yards. Because of site constraints, only one truck could be
moved into the delivery position at a time. Construction workers and electric
immersion-type concrete vibrators were also assumed for the process.

The simulation model of this process is illustrated in Figure 4-5. Node 2 signals the
availability of a concrete truck arriving from the batch plant. As with other circular
nodes in Figure 4-5, the availability of a truck may result in a resource waiting
or queueing for use. If a truck (node 2) and the crane (node 3) are both available,
then the crane can load and hoist a bucket of concrete (node 4). As with other
rectangular nodes in the model, this operation will require an appreciable period of
time. On the completion of the load and hoist operations, the bucket (node 5) is
available for concrete placement. Placement is accomplished by having a worker
guide the bucket's elephant trunk between the concrete forms and having a second
worker operate the bucket release lever. A third laborer operates a vibrator in the
concrete while the bucket (node 8) moves back to receive a new load. Once the
concrete placement is complete, the crew becomes available to place a new bucket
load (node 7). After two buckets are placed, then the column is complete (node 9)
and the equipment and crew can move to the next column (node 10). After the
movement to the new column is complete, placement in the new column can begin
(node 11). Finally, after a truck is emptied (nodes 12 and 13), the truck departs and
a new truck can enter the delivery stall (node 14) if one is waiting.

126
Figure 4-5: Illustration of a Concrete-Placing Simulation Model

Application of the simulation model consists of tracing through the time required
for these various operations. Events are also simulated such as the arrival times of
concrete trucks. If random elements are introduced, numerous simulations are

127
required to estimate the actual productivity and resource requirements of the
process. For example, one simulation of this process using four concrete trucks
found that a truck was waiting 83% of the time with an average wait at the site of
14 minutes. This type of simulation can be used to estimate the various productivity
adjustment factors described in the previous section.

Back to top

4.13 Queues and Resource Bottlenecks

A project manager needs to insure that resources required for and/or shared by
numerous activities are adequate. Problems in this area can be indicated in part by
the existence of queues of resource demands during construction operations.
A queue can be a waiting line for service. One can imagine a queue as an orderly
line of customers waiting for a stationary server such as a ticket seller. However,
the demands for service might not be so neatly arranged. For example, we can
speak of the queue of welds on a building site waiting for inspection. In this case,
demands do not come to the server, but a roving inspector travels among the
waiting service points. Waiting for resources such as a particular piece of
equipment or a particular individual is an endemic problem on construction sites. If
workers spend appreciable portions of time waiting for particular tools, materials or
an inspector, costs increase and productivity declines. Insuring adequate resources
to serve expected demands is an important problem during construction planning
and field management.

In general, there is a trade-off between waiting times and utilization of resources.

Utilization is the proportion of time a particular resource is in productive use.
Higher amounts of resource utilization will be beneficial as long as it does not
impose undue costs on the entire operation. For example, a welding inspector might
have one hundred percent utilization, but workers throughout the jobsite might be
wasting inordinate time waiting for inspections. Providing additional inspectors
may be cost effective, even if they are not utilized at all times.

A few conceptual models of queueing systems may be helpful to construction

planners in considering the level of adequate resources to provide. First, we shall
consider the case of time-varying demands and a server with a constant service rate.
This might be the situation for an elevator in which large demands for
transportation occur during the morning or at a shift change. Second, we shall
consider the situation of randomly arriving demands for service and constant
service rates. Finally, we shall consider briefly the problems involving multiple
serving stations.

Single-Server with Deterministic Arrivals and Services

128
Suppose that the cumulative number of demands for service or "customers" at any
time t is known and equal to the value of the function A(t). These "customers"
might be crane loads, weld inspections, or any other defined group of items to be
serviced. Suppose further that a single server is available to handle these demands,
such as a single crane or a single inspector. For this model of queueing, we assume
that the server can handle customers at some constant, maximum rate denoted as x
"customers" per unit of time. This is a maximum rate since the server may be idle
for periods of time if no customers are waiting. This system is deterministic in the
sense that both the arrival function and the service process are assumed to have no
random or unknown component.

Figure 4-6: Cumulative Arrivals and Departures in a Deterministic Queue

A cumulative arrival function of customers, A(t), is shown in Figure 4-6 in which

the vertical axis represents the cumulative number of customers, while the
horizontal axis represents the passage of time. The arrival of individual customers
to the queue would actually represent a unit step in the arrival function A(t), but
these small steps are approximated by a continuous curve in the figure. The rate of
arrivals for a unit time interval t from t-1 to t is given by:

4.14

While an hour or a minute is a natural choice as a unit time interval, other time
periods may also be used as long as the passage of time is expressed as multiples of
such time periods. For instance, if half an hour is used as unit time interval for a
process involving ten hours, then the arrivals should be represented by 20 steps of

129
half hour each. Hence, the unit time interval between t-1 and t is t = t - (t-1) = 1,
and the slope of the cumulative arrival function in the interval is given by:

4.15

The cumulative number of customers served over time is represented by the

cumulative departure function D(t). While the maximum service rate is x per unit
time, the actual service rate for a unit time interval t from t-1 to t is:

4.16

The slope of the cumulative departure function is:

4.17

Any time that the rate of arrivals to the queue exceeds the maximum service rate,
then a queue begins to form and the cumulative departures will occur at the
maximum service rate. The cumulative departures from the queue will proceed at
the maximum service rate of x "customers" per unit of time, so that the slope of
D(t) is x during this period. The cumulative departure function D(t) can be readily
constructed graphically by running a ruler with a slope of x along the cumulative
arrival function A(t). As soon as the function A(t) climbs above the ruler, a queue
begins to form. The maximum service rate will continue until the queue disappears,
which is represented by the convergence of the cumulative arrival and departure
functions A(t) and D(t).

With the cumulative arrivals and cumulative departure functions represented

graphically, a variety of service indicators can be readily obtained as shown in
Figure 4-6. Let A'(t) and D'(t) denote the derivatives of A(t) and D(t) with respect
to t, respectively. For 0 t ti in which A'(t) x, there is no queue. At t = ti, when
A'(t) > D'(t), a queue is formed. Then D'(t) = x in the interval t i t tk. As A'(t)
continues to increase with increasing t, the queue becomes longer since the service
rate D'(t) = x cannot catch up with the arrivals. However, when again A'(t) D'(t)
as t increases, the queue becomes shorter until it reaches 0 at t = tk. At any given
time t, the queue length is

4.18

For example, suppose a queue begins to form at time t i and is dispersed by time tk.
The maximum number of customers waiting or queue length is represented by the
maximum difference between the cumulative arrival and cumulative departure
functions between ti and tk, i.e. the maximum value of Q(t). The total waiting time

130
for service is indicated by the total area between the cumulative arrival and
cumulative departure functions.

Generally, the arrival rates At = 1, 2, . . ., n periods of a process as well as the

maximum service rate x are known. Then the cumulative arrival function and the
cumulative departure function can be constructed systematically together with other
pertinent quantities as follows:

1. Starting with the initial conditions D(t-1)=0 and Q(t-1)=0 at t=1, find the actual
service rate at t=1:

4.19

2. Starting with A(t-1)=0 at t=1, find the cumulative arrival function for t=2,3,. . .,n
accordingly:

4.20

3. Compute the queue length for t=1,2, . . .,n.

4.21

4. Compute Dt for t=2,3,. . .,n after Q(t-1) is found first for each t:

4.22

5. If A'(t) > x, find the cumulative departure function in the time period between
ti where a queue is formed and tk where the queue dissipates:

4.23

6. Compute the waiting time w for the arrivals which are waiting for service in
interval t:

4.24

7. Compute the total waiting time W over the time period between ti and tk.

4.25

8. Compute the average waiting time w for arrivals which are waiting for service in
the process.

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4.26

This simple, deterministic model has a number of implications for operations

planning. First, an increase in the maximum service rate will result in reductions in
waiting time and the maximum queue length. Such increases might be obtained by
speeding up the service rate such as introducing shorter inspection procedures or
installing faster cranes on a site. Second, altering the pattern of cumulative arrivals
can result in changes in total waiting time and in the maximum queue length. In
particular, if the maximum arrival rate never exceeds the maximum service rate, no
queue will form, or if the arrival rate always exceeds the maximum service rate, the
bottleneck cannot be dispersed. Both cases are shown in Figure 4-7.

Figure 4-7: Cases of No Queue and Permanent Bottleneck

A practical means to alter the arrival function and obtain these benefits is to
inaugurate a reservation system for customers. Even without drawing a graph such
as Figure 4-6, good operations planners should consider the effects of different
operation or service rates on the flow of work. Clearly, service rates less than the
expected arrival rate of work will result in resource bottlenecks on a job.

Single-Server with Random Arrivals and Constant Service Rate

Suppose that arrivals of "customers" to a queue are not deterministic or known as in

Figure 4-6. In particular, suppose that "customers" such as joints are completed or
crane loads arrive at random intervals. What are the implications for the smooth

132
flow of work? Unfortunately, bottlenecks and queues may arise in this situation
even if the maximum service rate is larger than the average or expected arrival rate
of customers. This occurs because random arrivals will often bunch together,
thereby temporarily exceeding the capacity of the system. While the average arrival
rate may not change over time, temporary resource shortages can occur in this
circumstance.

Let w be the average waiting time, a be the average arrival rate of customers, and x
be the deterministic constant service rate (in customers per unit of time). Then, the
expected average time for a customer in this situation is given by: [14]

4.27

If the average utilization rate of the service is defined as the ratio of the average
arrival rate and the constant service rate, i.e.,

4.28

Then, Eq. (4.27) becomes:

4.29

In this equation, the ratio u of arrival rate to service rate is very important: if the
average arrival rate approaches the service rate, the waiting time can be very long.
If a x, then the queue expands indefinitely. Resource bottlenecks will occur with
random arrivals unless a measure of extra service capacity is available to
accommodate sudden bunches in the arrival stream. Figure 4-8 illustrates the
waiting time resulting from different combinations of arrival rates and service
times.

133
Figure 4-8: Illustrative Waiting Times for Different Average Arrival Rates and
Service Times

Multiple Servers

Both of the simple models of service performance described above are limited to
single servers. In operations planning, it is commonly the case that numerous
operators are available and numerous stages of operations exist. In these
circumstances, a planner typically attempts to match the service rates occurring at
different stages in the process. For example, construction of a high rise building
involves a series of operations on each floor, including erection of structural
elements, pouring or assembling a floor, construction of walls, installation of
HVAC (Heating, ventilating and air conditioning) equipment, installation of
plumbing and electric wiring, etc. A smooth construction process would have each
of these various activities occurring at different floors at the same time without
large time gaps between activities on any particular floor. Thus, floors would be
installed soon after erection of structural elements, walls would follow
subsequently, and so on. From the standpoint of a queueing system, the planning
problem is to insure that the productivity or service rate per floor of these different
activities are approximately equal, so that one crew is not continually waiting on
the completion of a preceding activity or interfering with a following activity. In
the realm of manufacturing systems, creating this balance among operations is
called assembly line balancing.

134
Figure 4-9: Arrivals and Services of Crane Loads with a Crane Breakdown

Example 4-15: Effect of a crane breakdown

Suppose that loads for a crane are arriving at a steady rate of one every ten minutes.
The crane has the capacity to handle one load every five minutes. Suppose further
that the crane breaks down for ninety minutes. How many loads are delayed, what
is the total delay, and how long will be required before the crane can catch up with
the backlog of loads?

The cumulative arrival and service functions are graphed in Figure 4-9. Starting
with the breakdown at time zero, nine loads arrive during the ninety minute repair
time. From Figure 4-9, an additional nine loads arrive before the entire queue is
served. Algebraically, the required time for service, t, can be calculated by noted
that the number of arrivals must equal the number of loads served. Thus:

135
A queue is formed at t = 0 because of the breakdown, but it dissipates at A(t) =
D2(t). Let

from which we obtain t = 180 min. Hence

The total waiting time W can be calculated as the area between the cumulative
arrival and service functions in Figure 4-9. Algebraically, this is conveniently
calculated as the difference in the areas of two triangles:

so the average delay per load is w = 810/18 = 45 minutes.

Example 4-16: Waiting time with random arrivals

Suppose that material loads to be inspected arrive randomly but with an average of
5 arrivals per hour. Each load requires ten minutes for an inspection, so an
inspector can handle six loads per hour. Inspections must be completed before the
material can be unloaded from a truck. The cost per hour of holding a material load
in waiting is $30, representing the cost of a driver and a truck. In this example, the
arrival rate, a, equals 5 arrivals per hour and the service rate, x, equals 6 material
loads per hour. Then, the average waiting time of any material load for u = 5/6 is:

At a resource cost of $30.00 per hour, this waiting would represent a cost of (30)
(0.4)(5) = $60.00 per hour on the project.

In contrast, if the possible service rate is x = 10 material loads per hour, then the
expected waiting time of any material load for u = 5/10 = 0.5 is:

which has only a cost of (30)(0.05)(5) = $7.50 per hour.

136
Example 4-17: Delay of lift loads on a building site

Suppose that a single crane is available on a building site and that each lift requires
three minutes including the time for attaching loads. Suppose further that the
cumulative arrivals of lift loads at different time periods are as follows:

8 per
6:00-7:00 A.M. 4 per hour 12:00-4:00 P.M.
hour
15 per 4 per
7:00-8:00 A.M. 4:00-6:00 P.M.
hour hour
8:00-11:00 25 per 6:00P.M.-6:00 0 per
A.M. hour A.M. hour
11:00-12:00
5 per hour
A.M.

Using the above information of arrival and service rates

1. Find the cumulative arrivals and cumulative number of loads served as a

function of time, beginning with 6:00 AM.
2. Estimate the maximum queue length of loads waiting for service. What time
does the maximum queue occur?
3. Estimate the total waiting time for loads.
4. Graph the cumulative arrival and departure functions.

The maximum service rate x = 60 min/3 min per lift = 20 lifts per minute. The
detailed computation can be carried out in the Table 4-2, and the graph of A(t) and
D(t) is given in Figure 4-10.

Table 4-2 Computation of queue length and waiting time

Cumulative Cumulative
Arrival arrivals Departure departures Waiting
Period rate A(T) Queue rate D(T) time
6-7:00 4 4 0 4 4 0
7-8:00 15 19 0 15 19 0
8-9:00 25 44 5 20 39 5
9-10:00 25 69 10 20 59 10
10-11:00 25 94 15 20 79 15
11-12:00 5 99 0 20 99 0
12-1:00 8 107 0 8 107 0
1-2:00 8 115 0 8 115 0
2-3:00 8 123 0 8 123 0
3-4:00 8 131 0 8 131 0
4-5:00 4 135 0 4 135 0
5-6:00 4 139 0 4 139 0
6-7:00 0 139 0 0 139 0
7-8:00 0 139 0 0 139 0
Total waiting time = 30
Maximum queue = 15

137
Figure 4-10: Delay of Lift Loads on a Building Site

Back to top

4.14 References
1. Bourdon, C.C., and R.W. Levitt, Union and Open Shop Construction,
Lexington Books, D.C. Heath and Co., Lexington, MA, 1980.
2. Caterpillar Performance Handbook, 18@+(th) Edition, Caterpillar, Inc.,
Peoria, IL, 1987.
3. Cordell, R.H., "Construction Productivity Management," Cost Engineering,
Vol. 28, No. 2, February 1986, pp. 14-23.
4. Lange, J.E., and D.Q. Mills, The Construction Industry, Lexington Books,
D.C. Heath and Co., Lexington, MA, 1979.
5. Nunnally, S.W., Construction Methods and Management, Prentice-Hall,
Englewoood Cliffs, NJ, 2nd Ed., 1987.
6. Peurifoy, R.L., Construction Planning, Equipment and Methods, 2nd
Edition, McGraw-Hill, New York, 1970.
7. Tersine, R.J., Principles of Inventory and Materials Management, North
Holland, New York, 1982.

138
Back to top

4.15 Problems
1. Using the relationship between the productivity index and job size in
Example 4-1, determine the labor productivity for a new job requiring
350,000 labor hours under otherwise the same set of work conditions.

2. The potential labor hours available for a large energy complex were found to
be 5.4 million hours. The non-productive activities expressed in thousands of
labor hours were:
1. 360 for holidays and strikes
2. 1,152 for absentees
3. 785 for temporary stoppage
4. 1,084 for indirect labor

Determine the productive labor yield after the above factors are taken into
consideration.

3. Labor productivity at job site is known to decrease with overtime work. Let
x be the percentage of overtime over normal work week. If x is expressed in
decimals, the productivity index I as a function of the percentage of overtime
is found to be:

4. Find the value of the index I for x = 0, 0.1, 0.2, 0.3, 0.4 and 0.5 and plot the
relationship in a graph.

5. Labor productivity for a complex project is known to increase gradually in

the first 500,000 labor hours because of the learning effects. Let x be the
number of 100,000 labor hours. The labor productivity index I is found to be
a function of x as follows:

6. Find the value of the index I for x = 0, 1, 2, 3, 4 and 5 and plot the
relationship in a graph.

7. The probabilities for different delivery times of an item are given in the table
below. Find the expected delivery date of the item. Also find the lead time
required to provide an expected delivery date one day less than the desired
delivery date.
t p(t) Pr{T t}

139
 12 0.05 0.05
13 0.10 0.15
14 0.25 0.40
15 0.35 0.75
16 0.15 0.90
17 0.10 1.00
8. A power shovel with a dipper of two cubic yard capacity has a standard
operating cycle time of 80 seconds. The excavated material which has a
swell factor of 1.05 will be disposed by a dump truck with an 8 cubic yard
capacity at a dump site 6 miles away. The average speed of the dump truck
is 30 mph and the dumping time is 40 seconds. Find the daily standard
production rates of the power shovel and the dump truck if both are operated
8 hours per day. Determine also the number of trucks needed daily to
dispose of the excavated material.

9. The power shovel in Problem P6 has a daily standard production rate of 720
cubic yards. Determine the job site productivity and the actual cycle time of
this shovel under the work conditions at the site that affect the productivity
as shown below:
Work conditions at site Factors
Bulk composition 0.972
Soil properties and water content 0.960
Equipment idle time for breaks 0.750
Management inefficiency 0.750
10. Based on the information given for Problems P4-6 and P4-7, find the job site
productivity of a dump truck, assuming that the only factors affecting work
conditions are 0.85 for equipment idle time and 0.80 for management
efficiency. Also find the number of dump trucks required.

11.A Power shovel with a dipper of 1.5 cubic yard capacity has a standard
operating cycle time of 60 seconds. The excavated material which has a
swell factor of 1.08 will be disposed by a dump truck with a 7.5 cubic yard
capacity at a dumpsite 5 miles away. The average speed of a dump truck is
25 mph and the dumping time is 75 seconds. Both the power shovel and the
dump truck are operated 8 hours per day.
1. Find the daily standard production rate of the power shovel.
2. Find the daily standard production rate of the dump truck and number
of trucks required.
3. If the work conditions at the site that affect the productivity of the
shovel can be represented by four factors F1 = 0.940, F2 = 0.952, F3 =
0.850 and F4 = 0.750, determine the job-site productivity and the
actual cycle time.
4. If the work conditions at the site affect the productivity of the dump
truck can be represented by three factors F1 = 0.952, F2 = 0.700 and
F3 = 0.750, determine the job site productivity of the dump truck, and
the number of dump trucks required.

140
12.Suppose that a single piece of equipment is available on a site for testing
joints. Further, suppose that each joint has to be tested and certified before
work can proceed. Joints are completed and ready for testing at random
intervals during a shift. Each test requires an average of ten minutes. What is
the average utilization of the testing equipment and the average wait of a
completed joint for testing if the number of joints completed is (a) five per
hour or (b) three per hour.

13.Suppose that the steel plates to be inspected are arriving steadily at a rate of
one every twelve minutes. Each inspection requires sixteen minutes, but two
inspectors are available so the inspection service rate is one every eight
minutes. Suppose one inspector takes a break for sixty minutes. What is the
resulting delay in the arriving pieces? What is the average delay among the
pieces that have to wait?

14.Suppose that three machines are available in a fabrication ship for testing
welded joints of structural members so that the testing service rate of the
three machines is one in every 20 minutes. However, one of the three
machines is shut down for 90 minutes when the welded joints to be tested
arrive at a rate of one in every 25 minutes. What is the total delay for the
testing service of the arriving joints? What is the average delay? Sketch the
cumulative arrivals and services versus time.

15.Solve Example 4-17 if each lift requires 5 minutes instead of 3 minutes.

16. Solve Example 4-17 if each lift requires 6 minutes instead of 3 minutes

17.Suppose that up to 12 customers can be served per hour in an automated

inspection process. What is the total waiting time and maximum queue with
arrival rates for both cases (a) and (b) below:
(a) (b)
6-7:00 am 0 0
7-8:00 25 10
8-9:00 25 10
9-10:00 am 25 15
10-11:00 am 25 15
11-12:00 am 10 10
12-1:00 pm 8 15
1-2:00 pm 0 15
2-3:00 pm 0 10
3-4:00 pm 0 10
4-5:00 pm 0 10
After 5 pm 0 0
Total number of arrivals 118 120

141
 18.For the list of labor characteristic qualities in Section 4.3 (beginning with
Quality of Work and ending with Diversity), rate your own job performance
on the three point scale given.

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4.16 Footnotes
1. McCullough, David, The Path Between the Seas, Simon and Schuster, 1977, pg.
531. (Back)

2. Rosefielde, Steven and Daniel Quinn Mills, "Is Construction Technologically

Stagnant?", in Lange, Julian E. and Daniel Quinn Mills, The Construction Industry,
Lexington Books, 1979, pg. 83. (Back)

3. This example was adapted with permission from an unpublished paper

"Managing Mega Projects" presented by G.R. Desnoyers at the Project
Management Symposium sponsored by the Exxon Research and Engineering
Company, Florham Park, NJ, November 12, 1980. (Back)

4. See R.L. Tucker, "Perfection of the Buggy Whip," The Construction

Advancement Address, ASCE, Boston, MA, Oct. 29, 1986. (Back)

5. For more detailed discussion, see D.G. Mills: "Labor Relations and Collective
Bargaining" (Chapter 4) in The Construction Industry (by J.E. Lang and D.Q.
Mills), Lexington Books, D.C. Heath and Co., Lexington, MA, 1979. (Back)

6. This example was adapted from Stukhart, G. and Bell, L.C. "Costs and Benefits
of Materials Management Systems,", ASCE Journal of Construction Engineering
and Management, Vol. 113, No. 2, June 1987, pp. 222-234. (Back)

7. The information for this example was provided by Exxon Pipeline Company,
Houston, Texas, with permission from the Alyeska Pipeline Service Co.,
Anchorage, Alaska. (Back)

8. This example was adapted from A.E. Kerridge, "How to Develop a Project
Schedule," in A.E. Kerridge and C. H. Vervalin (eds.), Engineering and
Construction Project Management, Gulf Publishing Company, Houston,
1986. (Back)

9. For further details on equipment characteristics, see, for example, S.W.

Nunnally, Construction Methods and Management, Second Edition, Prentice-Hall,
1986 (Back)

142
10. See Paulson, C., "Automation and Robotics for Construction," ASCE Journal of
Construction Engineering and Management, Vol. 111, No. CO-3, 1985, pp. 190-
207. (Back)

11. This example is adapted from Fred Moavenzadeh, "Construction's High-

Technology Revolution," Technology Review, October, 1985, pg. 32. (Back)

12. This and the following examples in this section have been adapted from E.
Baracco-Miller and C.T. Hendrickson, Planning for Construction, Technical
Report No. R-87-162, Department of Civil Engineering, Carnegie Mellon
University, Pittsburgh, PA 1987. (Back)

13. This model used the INSIGHT simulation language and was described in B.C.
Paulson, W.T. Chan, and C.C. Koo, "Construction Operations Simulation by
Microcomputer," ASCE Journal of Construction Engineering and Management,
Vol. 113, No. CO-2, June 1987, pp. 302-314. (Back)

14. In the literature of queueing theory, this formula represents an M/D/1 queue,
meaning that the arrival process is Markovian or random, the service time is fixed,
only one server exists, and the system is in "steady state," implying that the service
time and average arrival rate are constant. Altering these assumptions would
require changes in the waiting time formula; for example, if service times were also
random, the waiting time formula would not have the 2 shown in the denominator
of Eq. (4.27). For more details on queueing systems, see Newell, G.F. Applications
of Queueing Theory, Chapman and Hall, London, 1982. (Back)

143
5. Cost Estimation
5.1 Costs Associated with Constructed Facilities
The costs of a constructed facility to the owner include both the initial capital cost
and the subsequent operation and maintenance costs. Each of these major cost
categories consists of a number of cost components.

The capital cost for a construction project includes the expenses related to the inital
establishment of the facility:

• Land acquisition, including assembly, holding and improvement

• Planning and feasibility studies
• Architectural and engineering design
• Construction, including materials, equipment and labor
• Field supervision of construction
• Construction financing
• Insurance and taxes during construction
• Owner's general office overhead
• Equipment and furnishings not included in construction
• Inspection and testing

The operation and maintenance cost in subsequent years over the project life cycle
includes the following expenses:

• Land rent, if applicable

• Operating staff
• Labor and material for maintenance and repairs
• Periodic renovations
• Insurance and taxes
• Financing costs
• Utilities
• Owner's other expenses

The magnitude of each of these cost components depends on the nature, size and
location of the project as well as the management organization, among many
considerations. The owner is interested in achieving the lowest possible overall
project cost that is consistent with its investment objectives.

It is important for design professionals and construction managers to realize that

while the construction cost may be the single largest component of the capital cost,
other cost components are not insignificant. For example, land acquisition costs are
a major expenditure for building construction in high-density urban areas, and

144
construction financing costs can reach the same order of magnitude as the
construction cost in large projects such as the construction of nuclear power plants.

From the owner's perspective, it is equally important to estimate the corresponding

operation and maintenance cost of each alternative for a proposed facility in order
to analyze the life cycle costs. The large expenditures needed for facility
maintenance, especially for publicly owned infrastructure, are reminders of the
neglect in the past to consider fully the implications of operation and maintenance
cost in the design stage.

In most construction budgets, there is an allowance for contingencies or unexpected

costs occuring during construction. This contingency amount may be included
within each cost item or be included in a single category of construction
contingency. The amount of contingency is based on historical experience and the
expected difficulty of a particular construction project. For example, one
construction firm makes estimates of the expected cost in five different areas:

• Design development changes,

• Schedule adjustments,
• General administration changes (such as wage rates),
• Differing site conditions for those expected, and
• Third party requirements imposed during construction, such as new permits.

Contingent amounts not spent for construction can be released near the end of
construction to the owner or to add additional project elements.

In this chapter, we shall focus on the estimation of construction cost, with only
occasional reference to other cost components. In Chapter 6, we shall deal with the
economic evaluation of a constructed facility on the basis of both the capital cost
and the operation and maintenance cost in the life cycle of the facility. It is at this
stage that tradeoffs between operating and capital costs can be analyzed.

Example 5-1: Energy project resource demands [1]

The resources demands for three types of major energy projects investigated during
the energy crisis in the 1970's are shown in Table 5-1. These projects are: (1) an oil
shale project with a capacity of 50,000 barrels of oil product per day; (2) a coal
gasification project that makes gas with a heating value of 320 billions of British
thermal units per day, or equivalent to about 50,000 barrels of oil product per day;
and (3) a tar sand project with a capacity of 150,000 barrels of oil product per day.

For each project, the cost in billions of dollars, the engineering manpower
requirement for basic design in thousands of hours, the engineering manpower
requirement for detailed engineering in millions of hours, the skilled labor
requirement for construction in millions of hours and the material requirement in

145
billions of dollars are shown in Table 5-1. To build several projects of such an
order of magnitude concurrently could drive up the costs and strain the availability
of all resources required to complete the projects. Consequently, cost estimation
often represents an exercise in professional judgment instead of merely compiling a
bill of quantities and collecting cost data to reach a total estimate mechanically.

TABLE 5-1 Resource Requirements of Some Major Energy Projects

Oil shale Coal gasification Tar Sands
(50,000 (320 billions (150,000
barrels/day) BTU/day) barrels/day)
Cost
2.5 4 8 to 10
($ billion)
Basic design
(Thousands of 80 200 100
hours)
Detailed
engineering
3 to 4 4 to 5 6 to 8
(Millions of
hours)
Construction
(Millions of 20 30 40
hours)
Materials
1 2 2.5
($ billion)
Source: Exxon Research and Engineering Company, Florham Park, NJ

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5.2 Approaches to Cost Estimation

Cost estimating is one of the most important steps in project management. A cost
estimate establishes the base line of the project cost at different stages of
development of the project. A cost estimate at a given stage of project development
represents a prediction provided by the cost engineer or estimator on the basis of
available data. According to the American Association of Cost Engineers, cost
engineering is defined as that area of engineering practice where engineering
judgment and experience are utilized in the application of scientific principles and
techniques to the problem of cost estimation, cost control and profitability.

Virtually all cost estimation is performed according to one or some combination of

the following basic approaches:

Production function. In microeconomics, the relationship between the output of a

process and the necessary resources is referred to as the production function. In
construction, the production function may be expressed by the relationship between
the volume of construction and a factor of production such as labor or capital. A

146
production function relates the amount or volume of output to the various inputs of
labor, material and equipment. For example, the amount of output Q may be
derived as a function of various input factors x1, x2, ..., xn by means of mathematical
and/or statistical methods. Thus, for a specified level of output, we may attempt to
find a set of values for the input factors so as to minimize the production cost. The
relationship between the size of a building project (expressed in square feet) to the
input labor (expressed in labor hours per square foot) is an example of a production
function for construction. Several such production functions are shown in Figure 3-
3 of Chapter 3.

Empirical cost inference. Empirical estimation of cost functions requires

statistical techniques which relate the cost of constructing or operating a facility to
a few important characteristics or attributes of the system. The role of statistical
inference is to estimate the best parameter values or constants in an assumed cost
function. Usually, this is accomplished by means of regression analysis techniques.

Unit costs for bill of quantities. A unit cost is assigned to each of the facility
components or tasks as represented by the bill of quantities. The total cost is the
summation of the products of the quantities multiplied by the corresponding unit
costs. The unit cost method is straightforward in principle but quite laborious in
application. The initial step is to break down or disaggregate a process into a
number of tasks. Collectively, these tasks must be completed for the construction of
a facility. Once these tasks are defined and quantities representing these tasks are
assessed, a unit cost is assigned to each and then the total cost is determined by
summing the costs incurred in each task. The level of detail in decomposing into
tasks will vary considerably from one estimate to another.

Allocation of joint costs. Allocations of cost from existing accounts may be used
to develop a cost function of an operation. The basic idea in this method is that
each expenditure item can be assigned to particular characteristics of the operation.
Ideally, the allocation of joint costs should be causally related to the category of
basic costs in an allocation process. In many instances, however, a causal
relationship between the allocation factor and the cost item cannot be identified or
may not exist. For example, in construction projects, the accounts for basic costs
may be classified according to (1) labor, (2) material, (3) construction equipment,
(4) construction supervision, and (5) general office overhead. These basic costs
may then be allocated proportionally to various tasks which are subdivisions of a
project.

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5.3 Types of Construction Cost Estimates

Construction cost constitutes only a fraction, though a substantial fraction, of the
total project cost. However, it is the part of the cost under the control of the

147
construction project manager. The required levels of accuracy of construction cost
estimates vary at different stages of project development, ranging from ball park
figures in the early stage to fairly reliable figures for budget control prior to
construction. Since design decisions made at the beginning stage of a project life
cycle are more tentative than those made at a later stage, the cost estimates made at
the earlier stage are expected to be less accurate. Generally, the accuracy of a cost
estimate will reflect the information available at the time of estimation.

Construction cost estimates may be viewed from different perspectives because of

different institutional requirements. In spite of the many types of cost estimates
used at different stages of a project, cost estimates can best be classified into three
major categories according to their functions. A construction cost estimate serves
one of the three basic functions: design, bid and control. For establishing the
financing of a project, either a design estimate or a bid estimate is used.

1. Design Estimates. For the owner or its designated design professionals, the
types of cost estimates encountered run parallel with the planning and design
as follows:
o Screening estimates (or order of magnitude estimates)
o Preliminary estimates (or conceptual estimates)
o Detailed estimates (or definitive estimates)
o Engineer's estimates based on plans and specifications

For each of these different estimates, the amount of design information

available typically increases.

2. Bid Estimates. For the contractor, a bid estimate submitted to the owner
either for competitive bidding or negotiation consists of direct construction
cost including field supervision, plus a markup to cover general overhead
and profits. The direct cost of construction for bid estimates is usually
derived from a combination of the following approaches.
o Subcontractor quotations
o Quantity takeoffs
o Construction procedures.
3. 3. Control Estimates. For monitoring the project during construction, a
control estimate is derived from available information to establish:
o Budget estimate for financing
o Budgeted cost after contracting but prior to construction
o Estimated cost to completion during the progress of construction.

Design Estimates

In the planning and design stages of a project, various design estimates reflect the
progress of the design. At the very early stage, the screening estimate or order of
magnitude estimate is usually made before the facility is designed, and must

148
therefore rely on the cost data of similar facilities built in the past. A preliminary
estimate or conceptual estimate is based on the conceptual design of the facility at
the state when the basic technologies for the design are known. The detailed
estimate or definitive estimate is made when the scope of work is clearly defined
and the detailed design is in progress so that the essential features of the facility are
identifiable. Theengineer's estimate is based on the completed plans and
specifications when they are ready for the owner to solicit bids from construction
contractors. In preparing these estimates, the design professional will include
expected amounts for contractors' overhead and profits.

The costs associated with a facility may be decomposed into a hierarchy of levels
that are appropriate for the purpose of cost estimation. The level of detail in
decomposing the facility into tasks depends on the type of cost estimate to be
prepared. For conceptual estimates, for example, the level of detail in defining tasks
is quite coarse; for detailed estimates, the level of detail can be quite fine.

As an example, consider the cost estimates for a proposed bridge across a river. A
screening estimate is made for each of the potential alternatives, such as a tied arch
bridge or a cantilever truss bridge. As the bridge type is selected, e.g. the
technology is chosen to be a tied arch bridge instead of some new bridge form, a
preliminary estimate is made on the basis of the layout of the selected bridge form
on the basis of the preliminary or conceptual design. When the detailed design has
progressed to a point when the essential details are known, a detailed estimate is
made on the basis of the well defined scope of the project. When the detailed plans
and specifications are completed, an engineer's estimate can be made on the basis
of items and quantities of work.

Bid Estimates

The contractor's bid estimates often reflect the desire of the contractor to secure the
job as well as the estimating tools at its disposal. Some contractors have well
established cost estimating procedures while others do not. Since only the lowest
bidder will be the winner of the contract in most bidding contests, any effort
devoted to cost estimating is a loss to the contractor who is not a successful bidder.
Consequently, the contractor may put in the least amount of possible effort for
making a cost estimate if it believes that its chance of success is not high.

If a general contractor intends to use subcontractors in the construction of a facility,

it may solicit price quotations for various tasks to be subcontracted to specialty
subcontractors. Thus, the general subcontractor will shift the burden of cost
estimating to subcontractors. If all or part of the construction is to be undertaken by
the general contractor, a bid estimate may be prepared on the basis of the quantity
takeoffs from the plans provided by the owner or on the basis of the construction
procedures devised by the contractor for implementing the project. For example,
the cost of a footing of a certain type and size may be found in commercial

149
publications on cost data which can be used to facilitate cost estimates from
quantity takeoffs. However, the contractor may want to assess the actual cost of
construction by considering the actual construction procedures to be used and the
associated costs if the project is deemed to be different from typical designs.
Hence, items such as labor, material and equipment needed to perform various
tasks may be used as parameters for the cost estimates.

Control Estimates

Both the owner and the contractor must adopt some base line for cost control
during the construction. For the owner, a budget estimate must be adopted early
enough for planning long term financing of the facility. Consequently, the detailed
estimate is often used as the budget estimate since it is sufficient definitive to
reflect the project scope and is available long before the engineer's estimate. As the
work progresses, the budgeted cost must be revised periodically to reflect the
estimated cost to completion. A revised estimated cost is necessary either because
of change orders initiated by the owner or due to unexpected cost overruns or
savings.

For the contractor, the bid estimate is usually regarded as the budget estimate,
which will be used for control purposes as well as for planning construction
financing. The budgeted cost should also be updated periodically to reflect the
estimated cost to completion as well as to insure adequate cash flows for the
completion of the project.

Example 5-2: Screening estimate of a grouting seal beneath a landfill [2]

One of the methods of isolating a landfill from groundwater is to create a bowl-

shaped bottom seal beneath the site as shown in Figure 5-0. The seal is constructed
by pumping or pressure-injecting grout under the existing landfill. Holes are bored
at regular intervals throughout the landfill for this purpose and the grout tubes are
extended from the surface to the bottom of the landfill. A layer of soil at a
minimum of 5 ft. thick is left between the grouted material and the landfill contents
to allow for irregularities in the bottom of the landfill. The grout liner can be
between 4 and 6 feet thick. A typical material would be Portland cement grout
pumped under pressure through tubes to fill voids in the soil. This grout would then
harden into a permanent, impermeable liner.

150
Figure 5-1: Grout Bottom Seal Liner at a Landfill

The work items in this project include (1) drilling exploratory bore holes at 50 ft
intervals for grout tubes, and (2) pumping grout into the voids of a soil layer
between 4 and 6 ft thick. The quantities for these two items are estimated on the
basis of the landfill area:

8 acres = (8)(43,560 ft2/acre) = 348,480 ft2

(As an approximation, use 360,000 ft2 to account for the bowl shape)

The number of bore holes in a 50 ft by 50 ft grid pattern covering 360,000 ft 2 is

given by:

The average depth of the bore holes is estimated to be 20 ft. Hence, the total
amount of drilling is (144)(20) = 2,880 ft.

The volume of the soil layer for grouting is estimated to be:

for a 4 ft layer, volume = (4 ft)(360,000 ft2) = 1,440,000 ft3

for a 6 ft layer, volume = (6 ft)(360,000 ft2) = 2,160,000 ft3

151
It is estimated from soil tests that the voids in the soil layer are between 20% and
30% of the total volume. Thus, for a 4 ft soil layer:
grouting in 20% voids = (20%)(1,440,000) = 288,000 ft3
grouting in 30 % voids = (30%)(1,440,000) = 432,000 ft3
and for a 6 ft soil layer:
grouting in 20% voids = (20%)(2,160,000) = 432,000 ft3
3
grouting in 30% voids = (30%)(2,160,000) = 648,000 ft
The unit cost for drilling exploratory bore holes is estimated to be between $3 and
$10 per foot (in 1978 dollars) including all expenses. Thus, the total cost of boring
will be between (2,880)(3) = $ 8,640 and (2,880)(10) = $28,800. The unit cost of
Portland cement grout pumped into place is between $4 and $10 per cubic foot
including overhead and profit. In addition to the variation in the unit cost, the total
cost of the bottom seal will depend upon the thickness of the soil layer grouted and
the proportion of voids in the soil. That is:
for a 4 ft layer with 20% voids, grouting cost = $1,152,000 to $2,880,000
for a 4 ft layer with 30% voids, grouting cost = $1,728,000 to $4,320,000
for a 6 ft layer with 20% voids, grouting cost = $1,728,000 to $4,320,000
for a 6 ft layer with 30% voids, grouting cost = $2,592,000 to $6,480,000
The total cost of drilling bore holes is so small in comparison with the cost of
grouting that the former can be omitted in the screening estimate. Furthermore, the
range of unit cost varies greatly with soil characteristics, and the engineer must
exercise judgment in narrowing the range of the total cost. Alternatively, additional
soil tests can be used to better estimate the unit cost of pumping grout and the
proportion of voids in the soil. Suppose that, in addition to ignoring the cost of bore
holes, an average value of a 5 ft soil layer with 25% voids is used together with a
unit cost of $ 7 per cubic foot of Portland cement grouting. In this case, the total
project cost is estimated to be:
(5 ft)(360,000 ft2)(25%)($7/ft3) = $3,150,000
An important point to note is that this screening estimate is based to a large degree
on engineering judgment of the soil characteristics, and the range of the actual cost
may vary from $ 1,152,000 to $ 6,480,000 even though the probabilities of having
actual costs at the extremes are not very high.
Example 5-3: Example of engineer's estimate and contractors' bids[3]
The engineer's estimate for a project involving 14 miles of Interstate 70 roadway in
Utah was $20,950,859. Bids were submitted on March 10, 1987, for completing the
project within 320 working days. The three low bidders were:

1. Ball, Ball & Brosame, Inc., Danville CA $14,129,798

2. National Projects, Inc., Phoenix, AR $15,381,789
3. Kiewit Western Co., Murray, Utah $18,146,714
It was astounding that the winning bid was 32% below the engineer's estimate.
Even the third lowest bidder was 13% below the engineer's estimate for this
project. The disparity in pricing can be attributed either to the very conservative
estimate of the engineer in the Utah Department of Transportation or to area
contractors who are hungrier than usual to win jobs.

152
The unit prices for different items of work submitted for this project by (1) Ball,
Ball & Brosame, Inc. and (2) National Projects, Inc. are shown in Table 5-2. The
similarity of their unit prices for some items and the disparity in others submitted
by the two contractors can be noted.

TABLE 5-2: Unit Prices in Two Contractors' Bids for Roadway Construction
Unit price
Items Unit Quantity
1 2
Mobilization ls 1 115,000 569,554
Removal, berm lf 8,020 1.00 1.50
Finish subgrade sy 1,207,500 0.50 0.30
Surface ditches lf 525 2.00 1.00
Excavation structures cy 7,000 3.00 5.00
Base course, untreated, 3/4'' ton 362,200 4.50 5.00
Lean concrete, 4'' thick sy 820,310 3.10 3.00
PCC, pavement, 10'' thick sy 76,010 10.90 12.00
Concrete, ci AA (AE) ls 1 200,000 190,000
Small structure cy 50 500 475
Barrier, precast lf 7,920 15.00 16.00
Flatwork, 4'' thick sy 7,410 10.00 8.00
10'' thick sy 4,241 20.00 27.00
Slope protection sy 2,104 25.00 30.00
Metal, end section, 15'' ea 39 100 125
18'' ea 3 150 200
Post, right-of-way, modification lf 4,700 3.00 2.50
Salvage and relay pipe lf 1,680 5.00 12.00
Loose riprap cy 32 40.00 30.00
Braced posts ea 54 100 110
Delineators, type I lb 1,330 12.00 12.00
type II ea 140 15.00 12.00
Constructive signs fixed sf 52,600 0.10 0.40
Barricades, type III lf 29,500 0.20 0.20
Warning lights day 6,300 0.10 0.50
Pavement marking, epoxy material
Black gal 475 90.00 100
Yellow gal 740 90.00 80.00
White gal 985 90.00 70.00
Plowable, one-way white ea 342 50.00 20.00

153
 TABLE 5-2: Unit Prices in Two Contractors' Bids for Roadway Construction
Unit price
Items Unit Quantity
Topsoil, contractor furnished cy 260 10.00 6.00
Seedling, method A acr 103 150 200
Excelsior blanket sy 500 2.00 2.00
Corrugated, metal pipe, 18'' lf 580 20.00 18.00
Polyethylene pipe, 12'' lf 2,250 15.00 13.00
Catch basin grate and frame ea 35 350 280
Equal opportunity training hr 18,000 0.80 0.80
Granular backfill borrow cy 274 10.00 16.00
Drill caisson, 2'x6'' lf 722 100 80.00
Flagging hr 20,000 8.25 12.50
Prestressed concrete member
type IV, 141'x4'' ea 7 12,000 16.00
132'x4'' ea 6 11,000 14.00
Reinforced steel lb 6,300 0.60 0.50
Epoxy coated lb 122,241 0.55 0.50
Structural steel ls 1 5,000 1,600
Sign, covering sf 16 10.00 4.00
type C-2 wood post sf 98 15.00 17.00
24'' ea 3 100 400
30'' ea 2 100 160
48'' ea 11 200 300
Auxiliary sf 61 15.00 12.00
Steel post, 48''x60'' ea 11 500 700
type 3, wood post sf 669 15.00 19.00
24'' ea 23 100 125
30'' ea 1 100 150
36'' ea 12 150 180
42''x60'' ea 8 150 220
48'' ea 7 200 270
Auxiliary sf 135 15.00 13.00
Steel post sf 1,610 40.00 35.00
12''x36'' ea 28 100 150
Foundation, concrete ea 60 300 650
Barricade, 48''x42'' ea 40 100 100
Wood post, road closed lf 100 30.00 36.00

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154
5.4 Effects of Scale on Construction Cost
Screening cost estimates are often based on a single variable representing the
capacity or some physical measure of the design such as floor area in buildings,
length of highways, volume of storage bins and production volumes of processing
plants. Costs do not always vary linearly with respect to different facility sizes.
Typically, scale economies or diseconomies exist. If the average cost per unit of
capacity is declining, then scale economies exist. Conversely, scale diseconomies
exist if average costs increase with greater size. Empirical data are sought to
establish the economies of scale for various types of facility, if they exist, in order
to take advantage of lower costs per unit of capacity.

Let x be a variable representing the facility capacity, and y be the resulting

construction cost. Then, a linear cost relationship can be expressed in the form:

(5.1)

where a and b are positive constants to be determined on the basis of historical

data. Note that in Equation (5.1), a fixed cost of y = a at x = 0 is implied as shown
in Figure 5-2. In general, this relationship is applicable only in a certain range of
the variable x, such as between x = c and x = d. If the values of y corresponding to
x = c and x = d are known, then the cost of a facility corresponding to any x within
the specified range may be obtained by linear interpolation. For example, the
construction cost of a school building can be estimated on the basis of a linear
relationship between cost and floor area if the unit cost per square foot of floor area
is known for school buildings within certain limits of size.

155
Figure 5-2: Linear Cost Relationship with Economies of Scale

A nonlinear cost relationship between the facility capacity x and construction cost y
can often be represented in the form:

(5.2)

where a and b are positive constants to be determined on the basis of historical

data. For 0 < b < 1, Equation (5.2) represents the case of increasing returns to scale,
and for b ;gt 1, the relationship becomes the case of decreasing returns to scale, as
shown in Figure 5-3. Taking the logarithm of both sides this equation, a linear
relationship can be obtained as follows:

Figure 5-3: Nonlinear Cost Relationship with increasing or Decreasing Economies

of Scale

(5.3)

Although no fixed cost is implied in Eq.(5.2), the equation is usually applicable

only for a certain range of x. The same limitation applies to Eq.(5.3). A nonlinear
cost relationship often used in estimating the cost of a new industrial processing
plant from the known cost of an existing facility of a different size is known as

156
the exponential rule. Let yn be the known cost of an existing facility with capacity
Qn, and y be the estimated cost of the new facility which has a capacity Q. Then,
from the empirical data, it can be assumed that:

(5.4)

where m usually varies from 0.5 to 0.9, depending on a specific type of facility. A
value of m = 0.6 is often used for chemical processing plants. The exponential rule
can be reduced to a linear relationship if the logarithm of Equation (5.4) is used:

(5.5)

or

(5.6)

The exponential rule can be applied to estimate the total cost of a complete facility
or the cost of some particular component of a facility.

Example 5-4: Determination of m for the exponential rule

Figure 5-4: Log-Log Scale Graph of Exponential Rule Example

The empirical cost data from a number of sewage treatment plants are plotted on a
log-log scale for ln(Q/Qn) and ln(y/yn) and a linear relationship between these
logarithmic ratios is shown in Figure 5-4. For (Q/Qn) = 1 or ln(Q/Qn) = 0, ln(y/yn) =
0; and for Q/Qn = 2 or ln(Q/Qn) = 0.301, ln(y/yn) = 0.1765. Since m is the slope of
the line in the figure, it can be determined from the geometric relation as follows:

157
For ln(y/yn) = 0.1765, y/yn = 1.5, while the corresponding value of Q/Qn is 2. In
words, for m = 0.585, the cost of a plant increases only 1.5 times when the capacity
is doubled.
Example 5-5: Cost exponents for water and wastewater treatment plants[4]
The magnitude of the cost exponent m in the exponential rule provides a simple
measure of the economy of scale associated with building extra capacity for future
growth and system reliability for the present in the design of treatment plants.
When m is small, there is considerable incentive to provide extra capacity since
scale economies exist as illustrated in Figure 5-3. When m is close to 1, the cost is
directly proportional to the design capacity. The value of m tends to increase as the
number of duplicate units in a system increases. The values of m for several types
of treatment plants with different plant components derived from statistical
correlation of actual construction costs are shown in Table 5-3.
TABLE 5-3 Estimated Values of Cost Exponents for Water Treatment Plants
Treatment plant Exponent Capacity range
type m (millions of gallons per day)
1. Water treatment 0.67 1-100
2. Waste treatment
Primary with digestion (small) 0.55 0.1-10
Primary with digestion (large) 0.75 0.7-100
Trickling filter 0.60 0.1-20
Activated sludge 0.77 0.1-100
Stabilization ponds 0.57 0.1-100
Source: Data are collected from various sources by P.M. Berthouex. See the references in his
article for the primary sources.

Example 5-6: Some Historical Cost Data for the Exponential Rule

The exponential rule as represented by Equation (5.4) can be expressed in a

different form as:

where

If m and K are known for a given type of facility, then the cost y for a proposed
new facility of specified capacity Q can be readily computed.
TABLE 5-4 Cost Factors of Processing Units for Treatment Plants
Processing Unit of K Value m
unit capacity (1968 $) value
1. Liquid processing

158
 Oil separation mgd 58,000 0.84
Hydroclone degritter mgd 3,820 0.35
Primary sedimentation ft2 399 0.60
Furial clarifier ft2 700 0.57
Sludge aeration basin mil. gal. 170,000 0.50
Tickling filter ft2 21,000 0.71
Aerated lagoon basin mil. gal. 46,000 0.67
Equalization mil. gal. 72,000 0.52
Neutralization mgd 60,000 0.70

2. Sludge handling
Digestion ft3 67,500 0.59
Vacuum filter ft2 9,360 0.84
lb dry
Centrifuge 318 0.81
solids/hr
Source: Data are collected from various sources by P.M. Berthouex. See the references in his
article for the primary sources.

The estimated values of K and m for various water and sewage treatment plant
components are shown in Table 5-4. The K values are based on 1968 dollars. The
range of data from which the K and m values are derived in the primary sources
should be observed in order to use them in making cost estimates.

As an example, take K = $399 and m = 0.60 for a primary sedimentation

component in Table 5-4. For a proposed new plant with the primary sedimentation
process having a capacity of 15,000 sq. ft., the estimated cost (in 1968 dollars) is:

y = ($399)(15,000)0.60 = $128,000.
Back to top

5.5 Unit Cost Method of Estimation

If the design technology for a facility has been specified, the project can be
decomposed into elements at various levels of detail for the purpose of cost
estimation. The unit cost for each element in the bill of quantities must be assessed
in order to compute the total construction cost. This concept is applicable to both
design estimates and bid estimates, although different elements may be selected in
the decomposition.

For design estimates, the unit cost method is commonly used when the project is
decomposed into elements at various levels of a hierarchy as follows:

1. Preliminary Estimates. The project is decomposed into major structural

systems or production equipment items, e.g. the entire floor of a building or
a cooling system for a processing plant.

159
 2. Detailed Estimates. The project is decomposed into components of various
major systems, i.e., a single floor panel for a building or a heat exchanger for
a cooling system.
3. Engineer's Estimates. The project is decomposed into detailed items of
various components as warranted by the available cost data. Examples of
detailed items are slabs and beams in a floor panel, or the piping and
connections for a heat exchanger.

For bid estimates, the unit cost method can also be applied even though the
contractor may choose to decompose the project into different levels in a hierarchy
as follows:

1. Subcontractor Quotations. The decomposition of a project into

subcontractor items for quotation involves a minimum amount of work for
the general contractor. However, the accuracy of the resulting estimate
depends on the reliability of the subcontractors since the general contractor
selects one among several contractor quotations submitted for each item of
subcontracted work.
2. Quantity Takeoffs. The decomposition of a project into items of quantities
that are measured (or taken off) from the engineer's plan will result in a
procedure similar to that adopted for a detailed estimate or an engineer's
estimate by the design professional. The levels of detail may vary according
to the desire of the general contractor and the availability of cost data.
3. Construction Procedures. If the construction procedure of a proposed
project is used as the basis of a cost estimate, the project may be
decomposed into items such as labor, material and equipment needed to
perform various tasks in the projects.

Simple Unit Cost Formula

Suppose that a project is decomposed into n elements for cost estimation. Let Qi be
the quantity of the ith element and ui be the corresponding unit cost. Then, the total
cost of the project is given by:

(5.7)

where n is the number of units. Based on characteristics of the construction site, the
technology employed, or the management of the construction process, the
estimated unit cost, ui for each element may be adjusted.

Factored Estimate Formula

A special application of the unit cost method is the "factored estimate" commonly
used in process industries. Usually, an industrial process requires several major

160
equipment components such as furnaces, towers drums and pump in a chemical
processing plant, plus ancillary items such as piping, valves and electrical elements.
The total cost of a project is dominated by the costs of purchasing and installing the
major equipment components and their ancillary items. Let Ci be the purchase cost
of a major equipment component i and fi be a factor accounting for the cost of
ancillary items needed for the installation of this equipment component i. Then, the
total cost of a project is estimated by:

(5.8)

where n is the number of major equipment components included in the project. The
factored method is essentially based on the principle of computing the cost of
ancillary items such as piping and valves as a fraction or a multiple of the costs of
the major equipment items. The value of Ci may be obtained by applying the
exponential rule so the use of Equation (5.8) may involve a combination of cost
estimation methods.

Formula Based on Labor, Material and Equipment

Consider the simple case for which costs of labor, material and equipment are
assigned to all tasks. Suppose that a project is decomposed into n tasks. Let Qi be
the quantity of work for task i, Mi be the unit material cost of task i, Ei be the unit
equipment rate for task i, Li be the units of labor required per unit of Qi, and Wi be
the wage rate associated with Li. In this case, the total cost y is:

(5.9)

Note that WiLi yields the labor cost per unit of Qi, or the labor unit cost of task i.
Consequently, the units for all terms in Equation (5.9) are consistent.

Example 5-7: Decomposition of a building foundation into design and

construction elements.

The concept of decomposition is illustrated by the example of estimating the costs

of a building foundation excluding excavation as shown in Table 5-5 in which the
decomposed design elements are shown on horizontal lines and the decomposed
contract elements are shown in vertical columns. For a design estimate, the
decomposition of the project into footings, foundation walls and elevator pit is
preferred since the designer can easily keep track of these design elements;
however, for a bid estimate, the decomposition of the project into formwork,
reinforcing bars and concrete may be preferred since the contractor can get
quotations of such contract items more conveniently from specialty subcontractors.
TABLE 5-5 Illustrative Decomposition of Building Foundation

161
 Costs
Design Contract elements
elements Formwork Rebars Concrete Total cost
Footings $5,000 $10,000 $13,000 $28,000
Foundation walls 15,000 18,000 28,000 61,000
Elevator pit 9,000 15,000 16,000 40,000
Total cost $29,000 $43,000 $57,000 $129,000

Example 5-8: Cost estimate using labor, material and equipment rates.

For the given quantities of work Qi for the concrete foundation of a building and
the labor, material and equipment rates in Table 5-6, the cost estimate is computed
on the basis of Equation (5.9). The result is tabulated in the last column of the same
table.
TABLE 5-6 Illustrative Cost Estimate Using Labor, Material and Equipment Rates
Material Equipment Wage Labor Labor Direct
Quantity
Description unit cost unit cost rate input unit cost cost
Qi
Mi Ei Wi Li WiLi Yi
Formwork 12,000 ft2 $0.4/ft2 $0.8/ft2 $15/hr 0.2 hr/ft2 $3.0/ft2 $50,400
Rebars 4,000 lb 0.2/lb 0.3/lb 15/hr 0.04 hr/lb 0.6/lb 4,440
Concrete 500 yd3 5.0/yd3 50/yd3 15/hr 0.8 hr/yd3 12.0/yd3 33,500
Total $88,300
Back to top

5.6 Methods for Allocation of Joint Costs

The principle of allocating joint costs to various elements in a project is often used
in cost estimating. Because of the difficulty in establishing casual relationship
between each element and its associated cost, the joint costs are often prorated in
proportion to the basic costs for various elements.

One common application is found in the allocation of field supervision cost among
the basic costs of various elements based on labor, material and equipment costs,
and the allocation of the general overhead cost to various elements according to the
basic and field supervision cost. Suppose that a project is decomposed into n tasks.
Let y be the total basic cost for the project and yi be the total basic cost for task i. If
F is the total field supervision cost and Fi is the proration of that cost to task i, then
a typical proportional allocation is:

(5.10)

162
Similarly, let z be the total direct field cost which includes the total basic cost and
the field supervision cost of the project, and zi be the direct field cost for task i. If G
is the general office overhead for proration to all tasks, and Gi is the share for task i,
then

(5.11)

Finally, let w be the grand total cost of the project which includes the direct field
cost and the general office overhead cost charged to the project and wi be that
attributable task i. Then,

(5.12)

and

(5.13)

Example 5-9: Prorated costs for field supervision and office overhead

If the field supervision cost is $13,245 for the project in Table 5-6 (Example 5-8)
with a total direct cost of $88,300, find the prorated field supervision costs for
various elements of the project. Furthermore, if the general office overhead charged
to the project is 4% of the direct field cost which is the sum of basic costs and field
supervision cost, find the prorated general office overhead costs for various
elements of the project.

For the project, y = $88,300 and F = $13,245. Hence:

z = 13,245 + 88,300 = $101,545

G = (0.04)(101,545) = $4,062
w = 101,545 + 4,062 = $105,607
The results of the proration of costs to various elements are shown in Table 5-7.
TABLE 5-7 Proration of Field Supervision and Office Overhead Costs
Allocated Total Allocated
Description Basic cost field supervision cost field cost overhead cost Total cost
yi Fi zi Gi Li
Formwork $50,400 $7,560 $57,960 $2,319 $60,279
Rebars 4,400 660 5,060 202 5,262

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 Concrete 33,500 5,025 38,525 1,541 40,066
Total $88,300 $13,245 $101,545 $4,062 $105,607

Example 5-10: A standard cost report for allocating overhead

The reliance on labor expenses as a means of allocating overhead burdens in typical

management accounting systems can be illustrated by the example of a particular
product's standard cost sheet. [5] Table 5-8 is an actual product's standard cost
sheet of a company following the procedure of using overhead burden rates
assessed per direct labor hour. The material and labor costs for manufacturing a
type of valve were estimated from engineering studies and from current material
and labor prices. These amounts are summarized in Columns 2 and 3 of Table 5-8.
The overhead costs shown in Column 4 of Table 5-8 were obtained by allocating
the expenses of several departments to the various products manufactured in these
departments in proportion to the labor cost. As shown in the last line of the table,
the material cost represents 29% of the total cost, while labor costs are 11% of the
total cost. The allocated overhead cost constitutes 60% of the total cost. Even
though material costs exceed labor costs, only the labor costs are used in allocating
overhead. Although this type of allocation method is common in industry, the
arbitrary allocation of joint costs introduces unintended cross subsidies among
products and may produce adverse consequences on sales and profits. For example,
a particular type of part may incur few overhead expenses in practice, but this
phenomenon would not be reflected in the standard cost report.
TABLE 5-8 Standard Cost Report for a Type of Valve
(1) Material (2) Labor (3) Overhead (4) Total
cost cost cost cost
Purchased part $1.1980 $1.1980
Operation
Drill, face, tap (2) $0.0438 $0.2404 $0.2842
Degrease 0.0031 0.0337 0.0368
Remove burs 0.0577 0.3241 0.3818
Total cost, this item 1.1980 0.1046 0.5982 1.9008
Other subassemblies 0.3523 0.2994 1.8519 2.4766
Total cost,
1.5233 0.4040 2.4501 4.3773
subassemblies
Assemble and test 0.1469 0.4987 0.6456
Pack without paper 0.0234 0.1349 0.1583
Total cost, this item $1.5233 $0.5743 $3.0837 $5.1813
Cost component, % 29% 11% 60% 100%
Source: H. T. Johnson and R. S. Kaplan, Relevance lost: The Rise and Fall of
Management Accounting, Harvard Business School Press, Boston. Reprinted with
permission.

Back to top

164
5.7 Historical Cost Data
Preparing cost estimates normally requires the use of historical data on construction
costs. Historical cost data will be useful for cost estimation only if they are
collected and organized in a way that is compatible with future applications.
Organizations which are engaged in cost estimation continually should keep a file
for their own use. The information must be updated with respect to changes that
will inevitably occur. The format of cost data, such as unit costs for various items,
should be organized according to the current standard of usage in the organization.

Construction cost data are published in various forms by a number of organizations.

These publications are useful as references for comparison. Basically, the following
types of information are available:

• Catalogs of vendors' data on important features and specifications relating to

their products for which cost quotations are either published or can be
obtained. A major source of vendors' information for building products
is Sweets' Catalog published by McGraw-Hill Information Systems
Company.
• Periodicals containing construction cost data and indices. One source of such
information is ENR, the McGraw-Hill Construction Weekly, which contains
extensive cost data including quarterly cost reports. Cost Engineering, a
journal of the American Society of Cost Engineers, also publishes useful
cost data periodically.
• Commercial cost reference manuals for estimating guides. An example is
the Building Construction Cost Data published annually by R.S. Means
Company, Inc., which contains unit prices on building construction
items. Dodge Manual for Building Construction, published by McGraw-Hill,
provides similar information.
• Digests of actual project costs. The Dodge Digest of Building Costs and
Specifications provides descriptions of design features and costs of actual
projects by building type. Once a week, ENR publishes the bid prices of a
project chosen from all types of construction projects.

Historical cost data must be used cautiously. Changes in relative prices may have
substantial impacts on construction costs which have increased in relative price.
Unfortunately, systematic changes over a long period of time for such factors are
difficult to predict. Errors in analysis also serve to introduce uncertainty into cost
estimates. It is difficult, of course, to foresee all the problems which may occur in
construction and operation of facilities. There is some evidence that estimates of
construction and operating costs have tended to persistently understate the actual
costs. This is due to the effects of greater than anticipated increases in costs,
changes in design during the construction process, or overoptimism.

165
Since the future prices of constructed facilities are influenced by many uncertain
factors, it is important to recognize that this risk must be borne to some degree by
all parties involved, i.e., the owner, the design professionals, the construction
contractors, and the financing institution. It is to the best interest of all parties that
the risk sharing scheme implicit in the design/construct process adopted by the
owner is fully understood by all. When inflation adjustment provisions have very
different risk implications to various parties, the price level changes will also be
treated differently for various situations. Back to top

5.8 Cost Indices

Since historical cost data are often used in making cost estimates, it is important to
note the price level changes over time. Trends in price changes can also serve as a
basis for forecasting future costs. The input price indices of labor and/or material
reflect the price level changes of such input components of construction; the output
price indices, where available, reflect the price level changes of the completed
facilities, thus to some degree also measuring the productivity of construction.

A price index is a weighted aggregate measure of constant quantities of goods and

services selected for the package. The price index at a subsequent year represents a
proportionate change in the same weighted aggregate measure because of changes
in prices. Let lt be the price index in year t, and lt+1 be the price index in the
following year t+1. Then, the percent change in price index for year t+1 is:

(5.14)

or

(5.15)

If the price index at the base year t=0 is set at a value of 100, then the price indices
l1, l2...ln for the subsequent years t=1,2...n can be computed successively from
changes in the total price charged for the package of goods measured in the index.

The best-known indicators of general price changes are the Gross Domestic
Product (GDP) deflators compiled periodically by the U.S. Department of
Commerce, and the consumer price index (CPI) compiled periodically by the U.S.
Department of Labor. They are widely used as broad gauges of the changes in
production costs and in consumer prices for essential goods and services. Special
price indices related to construction are also collected by industry sources since
some input factors for construction and the outputs from construction may

166
disproportionately outpace or fall behind the general price indices. Examples of
special price indices for construction input factors are the wholesale Building
Material Price and Building Trades Union Wages, both compiled by the U.S.
Department of Labor. In addition, the construction cost index and the building cost
index are reported periodically in the Engineering News-Record (ENR). Both ENR
cost indices measure the effects of wage rate and material price trends, but they are
not adjusted for productivity, efficiency, competitive conditions, or technology
changes. Consequently, all these indices measure only the price changes of
respective construction input factors as represented by constant quantities of
material and/or labor. On the other hand, the price indices of various types of
completed facilities reflect the price changes of construction output including all
pertinent factors in the construction process. The building construction output
indices compiled by Turner Construction Company and Handy-Whitman Utilities
are compiled in the U.S. Statistical Abstracts published each year.

Figure 5-7 and Table 5-9 show a variety of United States indices, including the
Gross Domestic Product (GDP) price deflator, the ENR building index, and the
Turner Construction Company Building Cost Index from 1996 to 2007, using 2000
as the base year with an index of 100.

TABLE 5-9 Summary of Input and Output Price Indices, 1996-2007

Year 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Turner
Construction -
Buildings 84.9 88.2 92.3 95.8 100.0 103.0 104.0 104.4 110.1 120.5 133.3 143.5
ENR - Buildings 90.5 95.0 95.8 97.6 100.0 101.0 102.4 104.4 112.6 118.8 123.5 126.7
GDP Deflator 94.0 95.6 96.8 98.0 100.0 102.3 104.2 105.9 107.2 108.6 110.2 112.0

Note: Index = 100 in base year of 2000.

167
Figure 5-7 Trends for US price indices.

Figure 5-8 Price and cost indices for construction.

Since construction costs vary in different regions of the United States and in all
parts of the world, locational indices showing the construction cost at a specific
location relative to the national trend are useful for cost estimation. ENR publishes
periodically the indices of local construction costs at the major cities in different
regions of the United States as percentages of local to national costs.

When the inflation rate is relatively small, i.e., less than 10%, it is convenient to
select a single price index to measure the inflationary conditions in construction
and thus to deal only with a single set of price change rates in forecasting. Let j t be
the price change rate in year t+1 over the price in year t. If the base year is denoted
as year 0 (t=0), then the price change rates at years 1,2,...t are j 1,j2,...jt, respectively.

168
Let At be the cost in year t expressed in base-year dollars and At' be the cost in year
t expressed in then-current dollars. Then:

(5.16)

Conversely

(5.17)

If the prices of certain key items affecting the estimates of future benefits and costs
are expected to escalate faster than the general price levels, it may become
necessary to consider the differential price changes over and above the general
inflation rate. For example, during the period between 1973 through 1979, it was
customary to assume that fuel costs would escalate faster than the general price
levels. With hindsight in 1983, the assumption for estimating costs over many years
would have been different. Because of the uncertainty in the future, the use of
differential inflation rates for special items should be judicious.

Future forecasts of costs will be uncertain: the actual expenses may be much lower
or much higher than those forecasted. This uncertainty arises from technological
changes, changes in relative prices, inaccurate forecasts of underlying
socioeconomic conditions, analytical errors, and other factors. For the purpose of
forecasting, it is often sufficient to project the trend of future prices by using a
constant rate j for price changes in each year over a period of t years, then

(5.18)

and

(5.19)

Estimation of the future rate increase j is not at all straightforward. A simple

expedient is to assume that future inflation will continue at the rate of the previous
period:

(5.20)

169
A longer term perspective might use the average increase over a horizon of n past
periods:

(5.21)

More sophisticated forecasting models to predict future cost increases include

corrections for items such as economic cycles and technology changes.

Example 5-12: Changes in highway and building costs

Figure 5-9 shows the change of standard highway costs from 1992 to 2002, and
Table 5-10 shows the change of residential building costs from 1970 to 1990. In
each case, the rate of cost increase was substantially above the rate of inflation in
the decade of the 1970s.. Indeed, the real cost increase between 1970 and 1980 was
in excess of three percent per year in both cases. However, these data also show
some cause for optimism. For the case of the standard highway, real
cost decreases took place in the period from l970 to l990. Unfortunately,
comparable indices of outputs are not being compiled on a nationwide basis for
other types of construction.

170
Figure 5-9 Producer Prices of Highway and Street Construction (Producer Price
Index: Highways and Streets-monthly data).

TABLE 5-10 Comparison of Residential Building Costs, 1970-1990

Standard Standard residence Percentage
residence cost Price deflator real cost change
year (1972=100) (1972=100) (1972=100) per year
1970 77 92 74
1980 203 179 99 +3.4%
1990 287 247 116 +1.7%
Source: Statistical Abstract of the United States. GNP deflator is used for the price deflator
index.

Back to top

5.9 Applications of Cost Indices to Estimating

In the screening estimate of a new facility, a single parameter is often used to
describe a cost function. For example, the cost of a power plant is a function of
electricity generating capacity expressed in megawatts, or the cost of a sewage
treatment plant as a function of waste flow expressed in million gallons per day.

The general conditions for the application of the single parameter cost function for
screening estimates are:

1. Exclude special local conditions in historical data

2. Determine new facility cost on basis of specified size or capacity (using the
methods described in Sections 5.3 to 5.6)
3. Adjust for inflation index
4. Adjust for local index of construction costs
5. Adjust for different regulatory constraints
6. Adjust for local factors for the new facility

Some of these adjustments may be done using compiled indices, whereas others
may require field investigation and considerable professional judgment to reflect
differences between a given project and standard projects performed in the past.

Example 5-13: Screening estimate for a refinery

The total construction cost of a refinery with a production capacity of 200,000

bbl/day in Gary, Indiana, completed in 2001 was $100 million. It is proposed that a
similar refinery with a production capacity of 300,000 bbl/day be built in Los
Angeles, California, for completion in 2003. For the additional information given
below, make an order of magnitude estimate of the cost of the proposed plant.

171
 1. In the total construction cost for the Gary, Indiana, plant, there was an item
of $5 million for site preparation which is not typical for other plants.
2. The variation of sizes of the refineries can be approximated by the
exponential rule, Equation (5.4), with m = 0.6.
3. The inflation rate is expected to be 8% per year from 1999 to 2003.
4. The location index was 0.92 for Gary, Indiana and 1.14 for Los Angeles in
1999. These indices are deemed to be appropriate for adjusting the costs
between these two cities.
5. New air pollution equipment for the LA plant costs $7 million in 2003
dollars (not required in the Gary plant).
6. The contingency cost due to inclement weather delay will be reduced by the
amount of 1% of total construction cost because of the favorable climate in
LA (compared to Gary).

On the basis of the above conditions, the estimate for the new project may be
obtained as follows:

1. Typical cost excluding special item at Gary, IN is

$100 million - $5 million = $ 95 million

2. Adjustment for capacity based on the exponential law yields

($95)(300,000/200,000)0.6 = (95)(1.5)0.6 = $121.2 million

3. Adjustment for inflation leads to the cost in 2003 dollars as

($121.2)(1.08)4 = $164.6 million

4. Adjustment for location index gives

($164.6)(1.14/0.92) = $204.6 million

5. Adjustment for new pollution equipment at the LA plant gives

$204.6 + $7 = $211.6 million

6. Reduction in contingency cost yields

($211.6)(1-0.01) = $209.5 million

Since there is no adjustment for the cost of construction financing, the order of
magnitude estimate for the new project is $209.5 million.
Example 5-14: Conceptual estimate for a chemical processing plant
In making a preliminary estimate of a chemical processing plant, several major
types of equipment are the most significant parameters in affecting the installation

172
cost. The cost of piping and other ancillary items for each type of equipment can
often be expressed as a percentage of that type of equipment for a given capacity.
The standard costs for the major equipment types for two plants with different daily
production capacities are as shown in Table 5-11. It has been established that the
installation cost of all equipment for a plant with daily production capacity between
100,000 bbl and 400,000 bbl can best be estimated by using linear interpolation of
the standard data.

TABLE 5-11 Cost Data for Equipment and Ancillary Items

Cost of ancillary items
Equipment Equipment Cost ($1000) as % of equipment cost ($1000)
type
100,000 bbl 400,000 bbl 100,000 bbl 400,000 bbl
Furnace 3,000 10,000 40% 30%
Tower 2,000 6,000 45% 35%
Drum 1,500 5,000 50% 40%
Pump, etc. 1,000 4,000 60% 50%

A new chemical processing plant with a daily production capacity of 200,000 bbl is
to be constructed in Memphis, TN in four years. Determine the total preliminary
cost estimate of the plant including the building and the equipment on the following
basis:

1. The installation cost for equipment was based on linear interpolation from
Table 5-11, and adjusted for inflation for the intervening four years. We
expect inflation in the four years to be similar to the period 1990-1994 and
we will use the GNP Deflator index.
2. The location index for equipment installation is 0.95 for Memphis, TN, in
comparison with the standard cost.
3. An additional cost of $500,000 was required for the local conditions in
Memphis, TN.

The solution of this problem can be carried out according to the steps as outlined in
the problem statement:

1. The costs of the equipment and ancillary items for a plant with a capacity of
200,000 bbl can be estimated by linear interpolation of the data in Table 5-
11 and the results are shown in Table 5-12.

TABLE 5-12 Results of Linear Interpolation for an Estimation Example

Equipment Equipment Cost Percentage for
type (in $1,000) ancillary items
Furnace $3,000 + (1/3)($10,000-$3,000) = $5,333 40% - (1/3)(40%-30%) = 37%
Tower $2,000 + (1/3)($6,000-$2,000) = $3,333 45% - (1/3)(45%-35%) = 42%

173
 Drum $1,500 + (1/3)($5,000-$1,500) = $2,667 50% - (1/3)(50%-40%) = 47%
Pumps, etc. $1,000 + (1/3)($4,000-$1,000) = $2,000 60% - (1/3)(60%-50%) = 57%
2. Hence, the total project cost in thousands of current dollars is given by
Equation (5.8) as:
3. ($5,333)(1.37) + ($3,333)(1.42) +($2,667)(1.47) + ($2,000)(1.57) =
= $2,307 + $4,733 + $3,920 + $3,140 = $ 19,000
4. The corresponding cost in thousands of four year in the future dollars using
Equation (5.16) and Table 5-9 is:

($19,100)(105/94) = $21,335

5. The total cost of the project after adjustment for location is

(0.95)($21,335,000) + $500,000 $20,800,000

Back to top

5.10 Estimate Based on Engineer's List of Quantities

The engineer's estimate is based on a list of items and the associated quantities
from which the total construction cost is derived. This same list is also made
available to the bidders if unit prices of the items on the list are also solicited from
the bidders. Thus, the itemized costs submitted by the winning contractor may be
used as the starting point for budget control.

In general, the progress payments to the contractor are based on the units of work
completed and the corresponding unit prices of the work items on the list. Hence,
the estimate based on the engineers' list of quanitities for various work items
essentially defines the level of detail to which subsequent measures of progress for
the project will be made.

Example 5-15: Bid estimate based on engineer's list of quantities

Using the unit prices in the bid of contractor 1 for the quantitites specified by the
engineer in Table 5-2 (Example 5-3), we can compute the total bid price of
contractor 1 for the roadway project. The itemized costs for various work items as
well as the total bid price are shown in Table 5-13.

TABLE 5-13: Bid Price of Contractor 1 in a Highway Project

Items Unit Quantity Unit price Item cost
Mobilization ls 1 115,000 115,000
Removal, berm lf 8,020 1.00 8.020
Finish subgrade sy 1,207,500 0.50 603,750

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TABLE 5-13: Bid Price of Contractor 1 in a Highway Project
Items Unit Quantity Unit price Item cost
Surface ditches lf 525 2.00 1,050
Excavation structures cy 7,000 3.00 21,000
Base course, untreated, 3/4'' ton 362,200 4.50 1,629,900
Lean concrete, 4'' thick sy 820,310 3.10 2,542,961
PCC, pavement, 10'' thick sy 76,010 10.90 7,695,509
Concrete, ci AA (AE) ls 1 200,000 200,000
Small structure cy 50 500 25,000
Barrier, precast lf 7,920 15.00 118,800
Flatwork, 4'' thick sy 7,410 10.00 74,100
10'' thick sy 4,241 20.00 84,820
Slope protection sy 2,104 25.00 52,600
Metal, end section, 15'' ea 39 100 3,900
18'' ea 3 150 450
Post, right-of-way, modification lf 4,700 3.00 14,100
Salvage and relay pipe lf 1,680 5.00 8,400
Loose riprap cy 32 40.00 1,280
Braced posts ea 54 100 5,400
Delineators, type I lb 1,330 12.00 15,960
type II ea 140 15.00 2,100
Constructive signs fixed sf 52,600 0.10 5,260
Barricades, type III lf 29,500 0.20 5,900
Warning lights day 6,300 0.10 630
Pavement marking, epoxy material
Black gal 475 90.00 42,750
Yellow gal 740 90.00 66,600
White gal 985 90.00 88,650
Plowable, one-way white ea 342 50.00 17,100
Topsoil, contractor furnished cy 260 10.00 2,600
Seedling, method A acr 103 150 15,450
Excelsior blanket sy 500 2.00 1,000
Corrugated, metal pipe, 18'' lf 580 20.00 11,600
Polyethylene pipe, 12'' lf 2,250 15.00 33,750
Catch basin grate and frame ea 35 350 12,250
Equal opportunity training hr 18,000 0.80 14,400
Granular backfill borrow cy 274 10.00 2,740
Drill caisson, 2'x6'' lf 722 100 72,200
Flagging hr 20,000 8.25 165,000

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 TABLE 5-13: Bid Price of Contractor 1 in a Highway Project
Items Unit Quantity Unit price Item cost
Prestressed concrete member
type IV, 141'x4'' ea 7 12,000 84,000
132'x4'' ea 6 11,000 66,000
Reinforced steel lb 6,300 0.60 3,780
Epoxy coated lb 122,241 0.55 67,232.55
Structural steel ls 1 5,000 5,000
Sign, covering sf 16 10.00 160
type C-2 wood post sf 98 15.00 1,470
24'' ea 3 100 300
30'' ea 2 100 200
48'' ea 11 200 2,200
Auxiliary sf 61 15.00 915
Steel post, 48''x60'' ea 11 500 5,500
type 3, wood post sf 669 15.00 10,035
24'' ea 23 100 2,300
30'' ea 1 100 100
36'' ea 12 150 1,800
42''x60'' ea 8 150 1,200
48'' ea 7 200 1,400
Auxiliary sf 135 15.00 2,025
Steel post sf 1,610 40.00 64,400
12''x36'' ea 28 100 2,800
Foundation, concrete ea 60 300 18,000
Barricade, 48''x42'' ea 40 100 4,000
Wood post, road closed lf 100 30.00 3,000
Total $14,129,797.55

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5.11 Allocation of Construction Costs Over Time

Since construction costs are incurred over the entire construction phase of a project,
it is often necessary to determine the amounts to be spent in various periods to
derive the cash flow profile, especially for large projects with long durations.
Consequently, it is important to examine the percentage of work expected to be
completed at various time periods to which the costs would be charged. More
accurate estimates may be accomplished once the project is scheduled as described

176
in Chapter 10, but some rough estimate of the cash flow may be required prior to
this time.

Consider the basic problem in determining the percentage of work completed

during construction. One common method of estimating percentage of completion
is based on the amount of money spent relative to the total amount budgeted for the
entire project. This method has the obvious drawback in assuming that the amount
of money spent has been used efficiently for production. A more reliable method is
based on the concept of value of work completed which is defined as the product of
the budgeted labor hours per unit of production and the actual number of
production units completed, and is expressed in budgeted labor hours for the work
completed. Then, the percentage of completion at any stage is the ratio of the value
of work completed to date and the value of work to be completed for the entire
project. Regardless of the method of measurement, it is informative to understand
the trend of work progress during construction for evaluation and control.

In general, the work on a construction project progresses gradually from the time of
mobilization until it reaches a plateau; then the work slows down gradually and
finally stops at the time of completion. The rate of work done during various time
periods (expressed in the percentage of project cost per unit time) is shown
schematically in Figure 5-10 in which ten time periods have been assumed. The
solid line A represents the case in which the rate of work is zero at time t = 0 and
increases linearly to 12.5% of project cost at t = 2, while the rate begins to decrease
from 12.5% at t = 8 to 0% at t = 10. The dotted line B represents the case of rapid
mobilization by reaching 12.5% of project cost at t = 1 while beginning to decrease
from 12.5% at t = 7 to 0% at t = 10. The dash line C represents the case of slow
mobilization by reaching 12.5% of project cost at t = 3 while beginning to decrease
from 12.5% at t = 9 to 0% at t = 10.

Figure 5-10: Rate of Work Progress over Project Time

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The value of work completed at a given time (expressed as a cumulative percentage
of project cost) is shown schematically in Figure 5-11. In each case (A, B or C), the
value of work completed can be represented by an "S-shaped" curve. The effects of
rapid mobilization and slow mobilization are indicated by the positions of curves B
and C relative to curve A, respectively.

Figure 5-11: Value of Work Completed over Project Time

While the curves shown in Figures 5-10 and 5-11 represent highly idealized cases,
they do suggest the latitude for adjusting the schedules for various activities in a
project. While the rate of work progress may be changed quite drastically within a
single period, such as the change from rapid mobilization to a slow mobilization in
periods 1, 2 and 3 in Figure 5-10, the effect on the value of work completed over
time will diminish in significance as indicated by the cumulative percentages for
later periods in Figure 5-11. Thus, adjustment of the scheduling of some activities
may improve the utilization of labor, material and equipment, and any delay caused
by such adjustments for individual activities is not likely to cause problems for the
eventual progress toward the completion of a project.

In addition to the speed of resource mobilization, another important consideration

is the overall duration of a project and the amount of resources applied. Various
strategies may be applied to shorten the overall duration of a project such as
overlapping design and construction activities (as described in Chapter 2) or

178
increasing the peak amounts of labor and equipment working on a site. However,
spatial, managerial and technical factors will typically place a minimum limit on
the project duration or cause costs to escalate with shorter durations.

Example 5-16: Calculation of Value of Work Completed

From the area of work progress in Figure 5-10, the value of work completed at any
point in Figure 5-11 can be derived by noting the area under the curve up to that
point in Figure 5-10. The result for t = 0 through t = 10 is shown in Table 5-14 and
plotted in Figure 5-11.

TABLE 5-14 Calculation of Value of Work Completed

Time Case A Case B Case C
0 0 0 0
1 3.1% 6.2% 2.1%
2 12.5 18.7 8.3
3 25.0 31.2 18.8
4 37.5 43.7 31.3
5 50.0 56.2 43.8
6 62.5 68.7 56.3
7 75.0 81.2 68.8
8 87.5 91.7 81.9
9 96.9 97.9 93.8
10 100.0 100.0 100.0

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5.12 Computer Aided Cost Estimation

Numerous computer aided cost estimation software systems are now available.
These range in sophistication from simple spreadsheet calculation software to
integrated systems involving design and price negotiation over the Internet. While
this software involves costs for purchase, maintenance, training and computer
hardware, some significant efficiencies often result. In particular, cost estimates
may be prepared more rapidly and with less effort.

Some of the common features of computer aided cost estimation software include:

• Databases for unit cost items such as worker wage rates, equipment rental or
material prices. These databases can be used for any cost estimate required.
If these rates change, cost estimates can be rapidly re-computed after the
databases are updated.

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 • Databases of expected productivity for different components types,
equiptment and construction processes.
• Import utilities from computer aided design software for automatic quantity-
take-off of components. Alternatively, special user interfaces may exist to
enter geometric descriptions of components to allow automatic quantity-
take-off.
• Export utilities to send estimates to cost control and scheduling software.
This is very helpful to begin the management of costs during construction.
• Version control to allow simulation of different construction processes or
design changes for the purpose of tracking changes in expected costs.
• Provisions for manual review, over-ride and editing of any cost element
resulting from the cost estimation system
• Flexible reporting formats, including provisions for electronic reporting
rather than simply printing cost estimates on paper.
• Archives of past projects to allow rapid cost-estimate updating or
modification for similar designs.

A typical process for developing a cost estimate using one of these systems would
include:

1. If a similar design has already been estimated or exists in the company

archive, the old project information is retreived.
2. A cost engineer modifies, add or deletes components in the project
information set. If a similar project exists, many of the components may
have few or no updates, thereby saving time.
3. A cost estimate is calculated using the unit cost method of estimation.
Productivities and unit prices are retrieved from the system databases. Thus,
the latest price information is used for the cost estimate.
4. The cost estimation is summarized and reviewed for any errors.

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5.13 Estimation of Operating Costs

In order to analyze the life cycle costs of a proposed facility, it is necessary to
estimate the operation and maintenance costs over time after the start up of the
facility. The stream of operating costs over the life of the facility depends upon
subsequent maintenance policies and facility use. In particular, the magnitude of
routine maintenance costs will be reduced if the facility undergoes periodic repairs
and rehabilitation at periodic intervals.

Since the tradeoff between the capital cost and the operating cost is an essential part
of the economic evaluation of a facility, the operating cost is viewed not as a
separate entity, but as a part of the larger parcel of life cycle cost at the planning
and design stage. The techniques of estimating life cycle costs are similar to those

180
used for estimating capital costs, including empirical cost functions and the unit
cost method of estimating the labor, material and equipment costs. However, it is
the interaction of the operating and capital costs which deserve special attention.

As suggested earlier in the discussion of the exponential rule for estimating, the
value of the cost exponent may influence the decision whether extra capacity
should be built to accommodate future growth. Similarly, the economy of scale
may also influence the decision on rehabilitation at a given time. As the
rehabilitation work becomes extensive, it becomes a capital project with all the
implications of its own life cycle. Hence, the cost estimation of a rehabilitation
project may also involve capital and operating costs.

While deferring the discussion of the economic evaluation of constructed facilities

to Chapter 6, it is sufficient to point out that the stream of operating costs over time
represents a series of costs at different time periods which have different values
with respect to the present. Consequently, the cost data at different time periods
must be converted to a common base line if meaningful comparison is desired.

Example 5-17: Maintenance cost on a roadway [6]

Maintenance costs for constructed roadways tend to increase with both age and use
of the facility. As an example, the following empirical model was estimated for
maintenance expenditures on sections of the Ohio Turnpike:

C = 596 + 0.0019 V + 21.7 A

where C is the annual cost of routine maintenance per lane-mile (in 1967 dollars),
V is the volume of traffic on the roadway (measured in equivalent standard axle
loads, ESAL, so that a heavy truck is represented as equivalent to many
automobiles), and A is the age of the pavement in years since the last resurfacing.
According to this model, routine maintenance costs will increase each year as the
pavement service deteriorates. In addition, maintenance costs increase with
additional pavement stress due to increased traffic or to heavier axle loads, as
reflected in the variable V.

For example, for V = 500,300 ESAL and A = 5 years, the annual cost of routine
maintenance per lane-mile is estimated to be:

C = 596 + (0.0019)(500,300) + (21.7)(5)

= 596 + 950.5 + 108.5 = 1,655 (in 1967 dollars)
Example 5-18: Time stream of costs over the life of a roadway [7]

The time stream of costs over the life of a roadway depends upon the intervals at
which rehabilitation is carried out. If the rehabilitation strategy and the traffic are
known, the time stream of costs can be estimated.

181
Using a life cycle model which predicts the economic life of highway pavement on
the basis of the effects of traffic and other factors, an optimal schedule for
rehabilitation can be developed. For example, a time stream of costs and
resurfacing projects for one pavement section is shown in Figure 5-11. As
described in the previous example, the routine maintenance costs increase as the
pavement ages, but decline after each new resurfacing. As the pavement continues
to age, resurfacing becomes more frequent until the roadway is completely
reconstructed at the end of 35 years.

Figure 5-11: Time Stream of Costs over the Life of a Highway Pavement

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5.14 References
1. Ahuja, H.N. and W.J. Campbell, Estimating: From Concept to Completion,
Prentice-Hall, Inc., Englewood Cliffs, NJ, 1987.
2. Clark, F.D., and A.B. Lorenzoni, Applied Cost Engineering, Marcel Dekker,
Inc., New York, 1978.
3. Clark, J.E., Structural Concrete Cost Estimating, McGraw-Hill, Inc., New
York, 1983.

182
 4. Diekmann, J.R., "Probabilistic Estimating: Mathematics and
Applications," ASCE Journal of Construction Engineering and
Management, Vol. 109, 1983, pp. 297-308.
5. Humphreys, K.K. (ed.) Project and Cost Engineers' Handbook (sponsored
by American Association of Cost Engineers), 2nd Ed., Marcel Dekker, Inc.,
New York, 1984.
6. Maevis, A.C., "Construction Cost Control by the Owners," ASCE Journal of
the Construction Division, Vol. 106, 1980, pp. 435-446.
7. Wohl, M. and C. Hendrickson, Transportation Investment and Pricing
Principles, John Wiley & Sons, New York, 1984.

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5.15 Problems
1. Suppose that the grouting method described in Example 5-2 is used to
provide a grouting seal beneath another landfill of 12 acres. The grout line is
expected to be between 4.5 and 5.5 feet thickness. The voids in the soil layer
are between 25% to 35%. Using the same unit cost data (in 1978 dollars),
find the range of costs in a screening estimate for the grouting project.

2. To avoid submerging part of U.S. Route 40 south and east of Salt Lake City
due to the construction of the Jardinal Dam and Reservoir, 22 miles of
highway were relocated to the west around the site of the future reservoir.
Three separate contracts were let, including one covering 10 miles of the
work which had an engineer's estimate of $34,095,545. The bids were
submitted on July 21, 1987 and the completion date of the project under the
contract was August 15, 1989. (See ENR, October 8, 1987, p. 34). The three
lowest bids were:
1) W.W. Clyde & Co., Springville, Utah $21,384,919
2) Sletten Construction company, Great Falls, Montana $26,701,018
3) Gilbert Western Corporation, Salt Lake city, Utah $30,896,203
3. Find the percentage of each of these bidders below the engineer's cost
estimate.

4. In making a screening estimate of an industrial plant for the production of

batteries, an empirical formula based on data of a similar buildings
completed before 1987 was proposed:

C = (16,000)(Q + 50,000)1/2

where Q is the daily production capacity of batteries and C is the cost of the
building in 1987 dollars. If a similar plant is planned for a daily production
capacity of 200,000 batteries, find the screening estimate of the building in
1987 dollars.

183
5. For the cost factor K = $46,000 (in 1968 dollars) and m = 0.67 for an aerated
lagoon basin of a water treatment plant in Table 5-4 (Example 5-6), find the
estimated cost of a proposed new plant with a similar treatment process
having a capacity of 480 million gallons (in 1968 dollars). If another new
plant was estimated to cost $160,000 by using the same exponential rule,
what would be the proposed capacity of that plant?

6. Using the cost data in Figure 5-5 (Example 5-11), find the total cost
including overhead and profit of excavating 90,000 cu.yd. of bulk material
using a backhoe of 1.5 cu.yd. capacity for a detailed estimate. Assume that
the excavated material will be loaded onto trucks for disposal.

7. The basic costs (labor, material and equipment) for various elements of a
construction project are given as follows:

Excavation $240,000
Subgrade $100,000
Base course $420,000
Concrete pavement $640,000
Total $1,400,000
8. Assuming that field supervision cost is 10% of the basic cost, and the
general office overhead is 5% of the direct costs (sum of the basic costs and
field supervision cost), find the prorated field supervision costs, general
office overhead costs and total costs for the various elements of the project.

9. In making a preliminary estimate of a chemical processing plant, several

major types of equipment are the most significant components in affecting
the installation cost. The cost of piping and other ancillary items for each
type of equipment can often be expressed as a percentage of that type of
equipment for a given capacity. The standard costs for the major equipment
types for two plants with different daily production capacities are as shown
in Table 5-15. It has been established that the installation cost of all
equipment for a plant with daily production capacity between 150,000 bbl
and 600,000 bbl can best be estimated by using liner interpolation of the
standard data. A new chemical processing plant with a daily production
capacity of 400,000 bbl is being planned. Assuming that all other factors
remain the same, estimate the cost of the new plant.

Table 5-15
Equipment cost ($1,000) Factor for ancillary items
Equipment type
150,000 bbl 600,000 bbl 150,000 bbl 600,000 bbl
Furnace $3,000 $10,000 0.32 0.24
Tower 2,000 6,000 0.42 0.36

184
 Drum 1,500 5,000 0.42 0.32
Pumps, etc. 1,000 4,000 0.54 0.42

10.The total construction cost of a refinery with a production capacity of

100,000 bbl/day in Caracas, Venezuela, completed in 1977 was $40 million.
It was proposed that a similar refinery with a production capacity of
$160,000 bbl/day be built in New Orleans, LA for completion in 1980. For
the additional information given below, make a screening estimate of the
cost of the proposed plant.
1. In the total construction cost for the Caracus, Venezuela plant, there
was an item of $2 million for site preparation and travel which is not
typical for similar plants.
2. The variation of sizes of the refineries can be approximated by the
exponential law with m = 0.6.
3. The inflation rate in U.S. dollars was approximately 9% per year from
1977 to 1980.
4. An adjustment factor of 1.40 was suggested for the project to account
for the increase of labor cost from Caracas, Venezuela to New
Orleans, LA.
5. New air pollution equipment for the New Orleans, LA plant cost $4
million in 1980 dollars (not required for the Caracas plant).
6. The site condition at New Orleans required special piling foundation
which cost $2 million in 1980 dollars.

11.The total cost of a sewage treatment plant with a capacity of 50 million

gallons per day completed 1981 for a new town in Colorado was $4.5
million. It was proposed that a similar treatment plant with a capacity of 80
million gallons per day be built in another town in New Jersey for
completion in 1985. For additional information given below, make a
screening estimate of the cost of the proposed plant.
1. In the total construction cost in Colorado, an item of $300,000 for site
preparation is not typical for similar plants.
2. The variation of sizes for this type of treatment plants can be
approximated by the exponential law with m = 0.5.
3. The inflation rate was approximately 5% per year from 1981 to 1985.
4. The locational indices of Colorado and New Jersey areas are 0.95 and
1.10, respectively, against the national average of 1.00.
5. The installation of a special equipment to satisfy the new
environmental standard cost an extra $200,000 in 1985 dollar for the
New Jersey plant.

185
 6. The site condition in New Jersey required special foundation which
cost $500,00 in 1985 dollars.

12. Using the ENR building cost index, estimate the 1985 cost of the grouting
seal on a landfill described in Example 5-2, including the most likely
estimate and the range of possible cost.

13.Using the unit prices in the bid of contractor 2 for the quantitites specified by
the engineer in Table 5-2 (Example 5-3), compute the total bid price of
contractor 2 for the roadway project including the expenditure on each item
of work.

14.The rate of work progress in percent of completion per period of a

construction project is shown in Figure 5-13 in which 13 time periods have
been assumed. The cases A, B and C represent the normal mobilization time,
rapid mobilization and slow mobilization for the project, respectively.
Calculate the value of work completed in cumulative percentage for periods
1 through 13 for each of the cases A, B and C. Also plot the volume of work
completed versus time for these cases.

Figure 5-13

15.The rate of work progress in percent of completion per period of a

construction project is shown in Figure 5-14 in which 10 time periods have
been assumed. The cases A, B and C represent the rapid mobilization time,
normal mobilization and slow mobilization for the project, respectively.
Calculate the value of work completed in cumulative percentage for periods

186
 1 through 10 for each of the cases A, B and C. Also plot the volume of work
completed versus time for these cases.

Figure 5-14

16. Suppose that the empirical model for estimating annual cost of routine
maintenance in Example 5-17 is applicable to sections of the Pennsylvania
Turnpike in 1985 if the ENR building cost index is applied to inflate the
1967 dollars. Estimate the annual cost of maintenance per lane-mile of the
tunrpike for which the traffic volume on the roadway is 750,000 ESAL and
the age of the pavement is 4 years in 1985.

17. The initial construction cost for a electric rower line is known to be a
function of the cross-sectional area A (in cm2) and the length L (in
kilometers). Let C1 be the unit cost of construction (in dollars per cm3).
Then, the initial construction cost P (in dollars) is given by

P = C1AL(105)

The annual operating cost of the power line is assumed to be measured by

the power loss. The power loss S (in kwh) is known to be

where J is the electric current in amperes, R is the resistivity in ohm-

centimeters. Let C2 be the unit operating cost (in dollars per kwh). Then, the
annual operating cost U (in dollars) is given by

187
 Suppose that the power line is expected to last n years and the life cycle cost
T of the power line is equal to:

T = P + UK

where K is a discount factor depending on the useful life cycle n and the
discount rate i (to be explained in Chapter 6). In designing the power line, all
quantitites are assumed to be known except A which is to be determined. If
the owner wants to minimize the life cycle cost, find the best cross-sectional
area A in terms of the known quantities.

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5.16 Footnotes
1. This example was adapted with permission from a paper, "Forecasting Industry
Resources," presented by A.R. Crosby at the Institution of Chemical Engineers in
London, November 4, 1981. (Back)

2. This example is adapted from a cost estimate in A.L. Tolman, A.P. Ballestero,
W.W. Beck and G.H. Emrich, Guidance Manual for Minimizing Pollution from
Waste Disposal Sites, Municipal Environmental Research Laboratory, U.S.
Environmental Protection Agency, Cincinatti, Ohio, 1978. (Back)

3. See "Utah Interstate Forges On," ENR, July 2, 1987, p. 39.(Back)

4. This and the next example have been adapted from P.M. Berthouex, "Evaluating
Economy of Scale," Journal of the Water Pollution Control Federation, Vol. 44,
No. 11, November 1972, pp. 2111-2118. (Back)

5. See H.T. Johnson and R.S. Kaplan, Relevance Lost: The Rise and Fall of
Management Accounting, Harvard Business School Press, Boston, MA 1987, p.
185. (Back)

6. This example is adapted from McNeil, S. and C. Hendrickson, "A Statistical

Model of Pavement Maintenance Expenditure," Transportation Research
Record No. 846, 1982, pp. 71-76. (Back)

7. This example is adapted from S. McNeil, Three Statistical Models of Road

Management Based on Turnpike Data, M.S. Thesis, Carnegie-Mellon University,
Pittsburgh, PA, 1981. (Back)

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6. Economic Evaluation of Facility
Investments
6.1 Project Life Cycle and Economic Feasibility
Facility investment decisions represent major commitments of corporate resources
and have serious consequences on the profitability and financial stability of a
corporation. In the public sector, such decisions also affect the viability of facility
investment programs and the credibility of the agency in charge of the programs. It
is important to evaluate facilities rationally with regard to both the economic
feasibility of individual projects and the relative net benefits of alternative and
mutually exclusive projects.

This chapter will present an overview of the decision process for economic
evaluation of facilities with regard to the project life cycle. The cycle begins with
the initial conception of the project and continues though planning, design,
procurement, construction, start-up, operation and maintenance. It ends with the
disposal of a facility when it is no longer productive or useful. Four major aspects
of economic evaluation will be examined:

1. The basic concepts of facility investment evaluation, including time

preference for consumption, opportunity cost, minimum attractive rate of
return, cash flows over the planning horizon and profit measures.
2. Methods of economic evaluation, including the net present value method, the
equivalent uniform annual value method, the benefit-cost ratio method, and
the internal rate of return method.
3. Factors affecting cash flows, including depreciation and tax effects, price
level changes, and treatment of risk and uncertainty.
4. Effects of different methods of financing on the selection of projects,
including types of financing and risk, public policies on regulation and
subsidies, the effects of project financial planning, and the interaction
between operational and financial planning.

In setting out the engineering economic analysis methods for facility investments, it
is important to emphasize that not all facility impacts can be easily estimated in
dollar amounts. For example, firms may choose to minimize environmental impacts
of construction or facilities in pursuit of a "triple bottom line:" economic,
environmental and social. By reducing environmental impacts, the firm may reap
benefits from an improved reputation and a more satisfied workforce. Nevertheless,
a rigorous economic evaluation can aid in making decisions for both quantifiable
and qualitative facility impacts.

189
It is important to distinguish between the economic evaluation of alternative
physical facilities and the evaluation of alternative financing plans for a project.
The former refers to the evaluation of the cash flow representing the benefits and
costs associated with the acquisition and operation of the facility, and this cash
flow over the planning horizon is referred to as the economic cash flow or
the operating cash flow. The latter refers to the evaluation of the cash flow
representing the incomes and expenditures as a result of adopting a specific
financing plan for funding the project, and this cash flow over the planning horizon
is referred to as the financial cash flow. In general, economic evaluation and
financial evaluation are carried out by different groups in an organization since
economic evaluation is related to design, construction, operations and maintenance
of the facility while financial evaluations require knowledge of financial assets
such as equities, bonds, notes and mortgages. The separation of economic
evaluation and financial evaluation does not necessarily mean one should ignore
the interaction of different designs and financing requirements over time
which may influence the relative desirability of specific design/financing
combinations. All such combinations can be duly considered. In practice, however,
the division of labor among two groups of specialists generally leads to sequential
decisions without adequate communication for analyzing the interaction of various
design/financing combinations because of the timing of separate analyses.

As long as the significance of the interaction of design/financing combinations is

understood, it is convenient first to consider the economic evaluation and financial
evaluation separately, and then combine the results of both evaluations to reach a
final conclusion. Consequently, this chapter is devoted primarily to the economic
evaluation of alternative physical facilities while the effects of a variety of
financing mechanisms will be treated in the next chapter. Since the methods of
analyzing economic cash flows are equally applicable to the analysis of financial
cash flows, the techniques for evaluating financing plans and the combined effects
of economic and financial cash flows for project selection are also included in this
chapter.

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6.2 Basic Concepts of Economic Evaluation

A systematic approach for economic evaluation of facilities consists of the
following major steps:

1. Generate a set of projects or purchases for investment consideration.

2. Establish the planning horizon for economic analysis.
3. Estimate the cash flow profile for each project.
4. Specify the minimum attractive rate of return (MARR).

190
 5. Establish the criterion for accepting or rejecting a proposal, or for selecting
the best among a group of mutually exclusive proposals, on the basis of the
objective of the investment.
6. Perform sensitivity or uncertainty analysis.
7. Accept or reject a proposal on the basis of the established criterion.

It is important to emphasize that many assumptions and policies, some implicit and
some explicit, are introduced in economic evaluation by the decision maker. The
decision making process will be influenced by the subjective judgment of the
management as much as by the result of systematic analysis.

The period of time to which the management of a firm or agency wishes to look
ahead is referred to as the planning horizon. Since the future is uncertain, the
period of time selected is limited by the ability to forecast with some degree of
accuracy. For capital investment, the selection of the planning horizon is often
influenced by the useful life of facilities, since the disposal of usable assets, once
acquired, generally involves suffering financial losses.

In economic evaluations, project alternatives are represented by their cash flow

profiles over the n years or periods in the planning horizon. Thus, the interest
periods are normally assumed to be in years t = 0,1,2, ...,n with t = 0 representing
the present time. Let Bt,x be the annual benefit at the end of year t for a investment
project x where x = 1, 2, ... refer to projects No. 1, No. 2, etc., respectively. Let
Ct,x be the annual cost at the end of year t for the same investment project x. The net
annual cash flow is defined as the annual benefit in excess of the annual cost, and is
denoted by At,x at the end of year t for an investment project x. Then, for t = 0,1, . . .
,n:

(6.1)

where At,x is positive, negative or zero depends on the values of Bt,x and Ct,x, both of
which are defined as positive quantities.

Once the management has committed funds to a specific project, it must forego
other investment opportunities which might have been undertaken by using the
same funds. The opportunity cost reflects the return that can be earned from the
best alternative investment opportunity foregone. The foregone opportunities may
include not only capital projects but also financial investments or other socially
desirable programs. Management should invest in a proposed project only if it will
yield a return at least equal to the minimum attractive rate of return (MARR) from
foregone opportunities as envisioned by the organization.

In general, the MARR specified by the top management in a private firm reflects
the opportunity cost of capital of the firm, the market interest rates for lending and

191
borrowing, and the risks associated with investment opportunities. For public
projects, the MARR is specified by a government agency, such as the Office of
Management and Budget or the Congress of the United States. The public MARR
thus specified reflects social and economic welfare considerations, and is referred
to as the social rate of discount.

Regardless of how the MARR is determined by an organization, the MARR

specified for the economic evaluation of investment proposals is critically
important in determining whether any investment proposal is worthwhile from the
standpoint of the organization. Since the MARR of an organization often cannot be
determined accurately, it is advisable to use several values of the MARR to assess
the sensitivity of the potential of the project to variations of the MARR value.

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6.3 Costs and Benefits of a Constructed Facility

The basic principle in assessing the economic costs and benefits of new facility
investments is to find the aggregate of individual changes in the welfare of all
parties affected by the proposed projects. The changes in welfare are generally
measured in monetary terms, but there are exceptions, since some effects cannot be
measured directly by cash receipts and disbursements. Examples include the value
of human lives saved through safety improvements or the cost of environmental
degradation. The difficulties in estimating future costs and benefits lie not only in
uncertainties and reliability of measurement, but also on the social costs and
benefits generated as side effects. Furthermore, proceeds and expenditures related
to financial transactions, such as interest and subsidies, must also be considered by
private firms and by public agencies.

To obtain an accurate estimate of costs in the cash flow profile for the acquisition
and operation of a project, it is necessary to specify the resources required to
construct and operate the proposed physical facility, given the available technology
and operating policy. Typically, each of the labor and material resources required
by the facility is multiplied by its price, and the products are then summed to obtain
the total costs. Private corporations generally ignore external social costs unless
required by law to do so. In the public sector, externalities often must be properly
accounted for. An example is the cost of property damage caused by air pollution
from a new plant. In any case, the measurement of external costs is extremely
difficult and somewhat subjective for lack of a market mechanism to provide even
approximate answers to the appropriate value.

In the private sector, the benefits derived from a facility investment are often
measured by the revenues generated from the operation of the facility. Revenues
are estimated by the total of price times quantity purchased. The depreciation
allowances and taxes on revenues must be deducted according to the prevailing tax

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laws. In the public sector, income may also be accrued to a public agency from the
operation of the facility. However, several other categories of benefits may also be
included in the evaluation of public projects. First, private benefits can be received
by users of a facility or service in excess of costs such as user charges or price
charged. After all, individuals only use a service or facility if their private benefit
exceeds their cost. These private benefits or consumer surplus represent a direct
benefit to members of the public. In many public projects, it is difficult, impossible
or impractical to charge for services received, so direct revenues equal zero and all
user benefits appear as consumers surplus. Examples are a park or roadways for
which entrance is free. As a second special category of public benefit, there may be
external or secondary beneficiaries of public projects, such as new jobs created and
profits to private suppliers. Estimating these secondary benefits is extremely
difficult since resources devoted to public projects might simply be displaced from
private employment and thus represent no net benefit.

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6.4 Interest Rates and the Costs of Capital

Constructed facilities are inherently long-term investments with a deferred pay-off.
The cost of capital or MARR depends on the real interest rate (i.e., market interest
rate less the inflation rate) over the period of investment. As the cost of capital
rises, it becomes less and less attractive to invest in a large facility because of the
opportunities foregone over a long period of time.

In Figure 6-1, the changes in the cost of capital from 1974 to 2002 are illustrated.
This figure presents the market interest rate on short and long term US treasury
borrowing, and the corresponding real interest rate over this period. The real
interest rate is calculated as the market interest rate less the general rate of
inflation. The real interest rates has varied substantially, ranging from 9% to -7%.
The exceptional nature of the 1980 to 1985 years is dramatically evident: the real
rate of interest reached remarkably high historic levels.

193
Figure 6-1 Nominal and Real Interest Rates on U.S. Bonds,

With these volatile interest rates, interest charges and the ultimate cost of projects
are uncertain. Organizations and institutional arrangements capable of dealing with
this uncertainty and able to respond to interest rate changes effectively would be
quite valuable. For example, banks offer both fixed rate and variable rate
mortgages. An owner who wants to limit its own risk may choose to take a fixed
rate mortgage even though the ultimate interest charges may be higher. On the
other hand, an owner who chooses a variable rate mortgage will have to adjust its
annual interest charges according to the market interest rates.

In economic evaluation, a constant value of MARR over the planning horizon is

often used to simplify the calculations. The use of a constant value for MARR is
justified on the ground of long-term average of the cost of capital over the period of
investment. If the benefits and costs over time are expressed in constant dollars, the
constant value for MARR represents the average real interest rate anticipated over
the planning horizon; if the benefits and costs over time are expressed in then-

194
current dollars, the constant value for MARR reflects the average market interest
rate anticipated over the planning horizon.

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6.5 Investment Profit Measures

A profit measure is defined as an indicator of the desirability of a project from the
standpoint of a decision maker. A profit measure may or may not be used as the
basis for project selection. Since various profit measures are used by decision
makers for different purposes, the advantages and restrictions for using these profit
measures should be fully understood.

There are several profit measures that are commonly used by decision makers in
both private corporations and public agencies. Each of these measures is intended
to be an indicator of profit or net benefit for a project under consideration. Some of
these measures indicate the size of the profit at a specific point in time; others give
the rate of return per period when the capital is in use or when reinvestments of the
early profits are also included. If a decision maker understands clearly the meaning
of the various profit measures for a given project, there is no reason why one
cannot use all of them for the restrictive purposes for which they are appropriate.
With the availability of computer based analysis and commercial software, it takes
only a few seconds to compute these profit measures. However, it is important to
define these measures precisely:

1. Net Future Value and Net Present Value. When an organization makes an
investment, the decision maker looks forward to the gain over a planning horizon,
against what might be gained if the money were invested elsewhere. A minimum
attractive rate of return (MARR) is adopted to reflect this opportunity cost of
capital. The MARR is used for compounding the estimated cash flows to the end of
the planning horizon, or for discounting the cash flow to the present. The
profitability is measured by the net future value (NFV) which is the net return at the
end of the planning horizon above what might have been gained by investing
elsewhere at the MARR. The net present value (NPV) of the estimated cash flows
over the planning horizon is the discounted value of the NFV to the present. A
positive NPV for a project indicates the present value of the net gain corresponding
to the project cash flows.

2. Equivalent Uniform Annual Net Value. The equivalent uniform annual net
value (NUV) is a constant stream of benefits less costs at equally spaced time
periods over the intended planning horizon of a project. This value can be
calculated as the net present value multiplied by an appropriate "capital recovery
factor." It is a measure of the net return of a project on an annualized or amortized
basis. The equivalent uniform annual cost (EUAC) can be obtained by multiplying
the present value of costs by an appropriate capital recovery factor. The use of

195
EUAC alone presupposes that the discounted benefits of all potential projects over
the planning horizon are identical and therefore only the discounted costs of
various projects need be considered. Therefore, the EUAC is an indicator of the
negative attribute of a project which should be minimized.

3. Benefit Cost Ratio. The benefit-cost ratio (BCR), defined as the ratio of
discounted benefits to the discounted costs at the same point in time, is a
profitability index based on discounted benefits per unit of discounted costs of a
project. It is sometimes referred to as the savings-to-investment ratio (SIR) when
the benefits are derived from the reduction of undesirable effects. Its use also
requires the choice of a planning horizon and a MARR. Since some savings may be
interpreted as a negative cost to be deducted from the denominator or as a positive
benefit to be added to the numerator of the ratio, the BCR or SIR is not an absolute
numerical measure. However, if the ratio of the present value of benefit to the
present value of cost exceeds one, the project is profitable irrespective of different
interpretations of such benefits or costs.

4. Internal Rate of Return. The internal rate of return (IRR) is defined as the
discount rate which sets the net present value of a series of cash flows over the
planning horizon equal to zero. It is used as a profit measure since it has been
identified as the "marginal efficiency of capital" or the "rate of return over cost".
The IRR gives the return of an investment when the capital is in use as if the
investment consists of a single outlay at the beginning and generates a stream of net
benefits afterwards. However, the IRR does not take into consideration the
reinvestment opportunities related to the timing and intensity of the outlays and
returns at the intermediate points over the planning horizon. For cash flows with
two or more sign reversals of the cash flows in any period, there may exist multiple
values of IRR; in such cases, the multiple values are subject to various
interpretations.

5. Adjusted Internal Rate of Return. If the financing and reinvestment policies

are incorporated into the evaluation of a project, an adjusted internal rate of return
(AIRR) which reflects such policies may be a useful indicator of profitability under
restricted circumstances. Because of the complexity of financing and reinvestment
policies used by an organization over the life of a project, the AIRR seldom can
reflect the reality of actual cash flows. However, it offers an approximate value of
the yield on an investment for which two or more sign reversals in the cash flows
would result in multiple values of IRR. The adjusted internal rate of return is
usually calculated as the internal rate of return on the project cash flow modified so
that all costs are discounted to the present and all benefits are compounded to the
end of the planning horizon.

6. Return on Investment. When an accountant reports income in each year of a

multi-year project, the stream of cash flows must be broken up into annual rates of
return for those years. The return on investment (ROI) as used by accountants

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usually means the accountant's rate of return for each year of the project duration
based on the ratio of the income (revenue less depreciation) for each year and the
undepreciated asset value (investment) for that same year. Hence, the ROI is
different from year to year, with a very low value at the early years and a high
value in the later years of the project.

7. Payback Period. The payback period (PBP) refers to the length of time within
which the benefits received from an investment can repay the costs incurred during
the time in question while ignoring the remaining time periods in the planning
horizon. Even the discounted payback period indicating the "capital recovery
period" does not reflect the magnitude or direction of the cash flows in the
remaining periods. However, if a project is found to be profitable by other
measures, the payback period can be used as a secondary measure of the financing
requirements for a project.

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6.6 Methods of Economic Evaluation

The objective of facility investment in the private sector is generally understood to
be profit maximization within a specific time frame. Similarly, the objective in the
public sector is the maximization of net social benefit which is analogous to profit
maximization in private organizations. Given this objective, a method of economic
analysis will be judged by the reliability and ease with which a correct conclusion
may be reached in project selection.

The basic principle underlying the decision for accepting and selecting investment
projects is that if an organization can lend or borrow as much money as it wishes at
the MARR, the goal of profit maximization is best served by accepting all
independent projects whose net present values based on the specified MARR are
nonnegative, or by selecting the project with the maximum nonnegative net present
value among a set of mutually exclusive proposals. The net present value criterion
reflects this principle and is most straightforward and unambiguous when there is
no budget constraint. Various methods of economic evaluation, when properly
applied, will produce the same result if the net present value criterion is used as the
basis for decision. For convenience of computation, a set of tables for the various
compound interest factors is given in Appendix A.

Net Present Value Method

Let BPVx be the present value of benefits of a project x and CPVx be the present
value of costs of the project x. Then, for MARR = i over a planning horizon of n
years,

197
(6.2)

(6.3)

where the symbol (P|F,i,t) is a discount factor equal to (1+i)-t and reads as follows:
"To find the present value P, given the future value F=1, discounted at an annual
discount rate i over a period of t years." When the benefit or cost in year t is
multiplied by this factor, the present value is obtained. Then, the net present value
of the project x is calculated as:

(6.4)

or

(6.5)

If there is no budget constraint, then all independent projects having net present
values greater than or equal to zero are acceptable. That is, project x is acceptable
as long as

(6.6)

For mutually exclusive proposals (x = 1,2,...,m), a proposal j should be selected if it

has the maximum nonnegative net present value among all m proposals, i.e.

(6.7)

provided that NPVj 0.

Net Future Value Method

Since the cash flow profile of an investment can be represented by its equivalent
value at any specified reference point in time, the net future value (NFVx) of a

198
series of cash flows At,x (for t=0,1,2,...,n) for project x is as good a measure of
economic potential as the net present value. Equivalent future values are obtained
by multiplying a present value by the compound interest factor (F|P,i,n) which is
(1+i)n. Specifically,

(6.8)

Consequently, if NPVx 0, it follows that NFVx 0, and vice versa.

Net Equivalent Uniform Annual Value Method

The net equivalent uniform annual value (NUVx) refers to a uniform series over a
planning horizon of n years whose net present value is that of a series of cash flow
At,x (for t= 1,2,...,n) representing project x. That is,

(6.9)

where the symbol (U|P,i,n) is referred to as the capital recovery factor and reads as
follows: "To find the equivalent annual uniform amount U, given the present value
P=1, discounted at an annual discount rate i over a period of t years." Hence, if
NPVx 0, it follows that NUVx 0, and vice versa.

Benefit-Cost Ratio Method

The benefit-cost ratio method is not as straightforward and unambiguous as the net
present value method but, if applied correctly, will produce the same results as the
net present value method. While this method is often used in the evaluation of
public projects, the results may be misleading if proper care is not exercised in its
application to mutually exclusive proposals.

The benefit-cost ratio is defined as the ratio of the discounted benefits to the
discounted cost at the same point in time. In view of Eqs. (6.4) and (6.6), it follows
that the criterion for accepting an independent project on the basis of the benefit-
cost ratio is whether or not the benefit-cost ratio is greater than or equal to one:

(6.10)

However, a project with the maximum benefit-cost ratio among a group

of mutually exclusive proposals generally does not necessarily lead to the maximum
net benefit. Consequently, it is necessary to perform incremental analysis through

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pairwise comparisons of such proposals in selecting the best in the group. In effect,
pairwise comparisons are used to determine if incremental increases in costs
between projects yields larger incremental increases in benefits. This approach is
not recommended for use in selecting the best among mutually exclusive proposals.

Internal Rate of Return Method

The term internal rate of return method has been used by different analysts to mean
somewhat different procedures for economic evaluation. The method is often
misunderstood and misused, and its popularity among analysts in the private sector
is undeserved even when the method is defined and interpreted in the most
favorable light. The method is usually applied by comparing the MARR to the
internal rate of return value(s) for a project or a set of projects.

A major difficulty in applying the internal rate of return method to economic

evaluation is the possible existence of multiple values of IRR when there are two or
more changes of sign in the cash flow profile At,x (for t=0,1,2,...,n). When that
happens, the method is generally not applicable either in determining the
acceptance of independent projects or for selection of the best among a group of
mutually exclusive proposals unless a set of well defined decision rules are
introduced for incremental analysis. In any case, no advantage is gained by using
this method since the procedure is cumbersome even if the method is correctly
applied. This method is not recommended for use either in accepting independent
projects or in selecting the best among mutually exclusive proposals.

Example 6-1: Evaluation of Four Independent Projects

The cash flow profiles of four independent projects are shown in Table 6-1. Using a
MARR of 20%, determine the acceptability of each of the projects on the basis of
the net present value criterion for accepting independent projects.
TABLE 6-1 Cash Flow Profiles of Four Independent Projects (in $ million)
t At,1 At,2 At,3 At,4
0 -77.0 -75.3 -39.9 18.0
1 0 28.0 28.0 10.0
2 0 28.0 28.0 -40.0
3 0 28.0 28.0 -60.0
4 0 28.0 28.0 30.0
5 235.0 28.0 -80.0 50.0

Using i = 20%, we can compute NPV for x = 1, 2, 3, and 4 from Eq. (6.5). Then,
the acceptability of each project can be determined from Eq. (6.6). Thus,

[NPV1]20% = -77 + (235)(P|F, 20%, 5) = -77 + 94.4 = 17.4

[NPV2]20% = -75.3 + (28)(P|U, 20%, 5) = -75.3 + 83.7 = 8.4
[NPV3]20% = -39.9 + (28)(P|U, 20%, 4) - (80)(P|F, 20%, 5)

200
 = -39.9 + 72.5 - 32.2 = 0.4
[NPV4]20% = 18 + (10)(P|F, 20%, 1) - (40)(P|F, 20%, 2)
- (60)(P|F, 20%, 3) + (30)(P|F, 20%, 4) + (50)(P|F, 20%, 5)
= 18 + 8.3 - 27.8 - 34.7 + 14.5 + 20.1 = -1.6

Hence, the first three independent projects are acceptable, but the last project
should be rejected.

It is interesting to note that if the four projects are mutually exclusive, the net
present value method can still be used to evaluate the projects and, according to Eq.
(6.7), the project (x = 1) which has the highest positive NPV should be selected.
The use of the net equivalent uniform annual value or the net future value method
will lead to the same conclusion. However, the project with the highest benefit-cost
ratio is not necessarily the best choice among a group of mutually exclusive
alternatives. Furthermore, the conventional internal rate of return method cannot be
used to make a meaningful evaluation of these projects as the IRR for both x=1 and
x=2 are found to be 25% while multiple values of IRR exist for both the x=3 and
x=4 alternatives.

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6.7 Depreciation and Tax Effects

For private corporations, the cash flow profile of a project is affected by the amount
of taxation. In the context of tax liability, depreciation is the amount allowed as a
deduction due to capital expenses in computing taxable income and, hence, income
tax in any year. Thus, depreciation results in a reduction in tax liabilities.

It is important to differentiate between the estimated useful life used in depreciation

computations and the actual useful life of a facility. The former is often an arbitrary
length of time, specified in the regulations of the U.S. Internal Revenue Service or
a comparable organization. The depreciation allowance is a bookkeeping entry that
does not involve an outlay of cash, but represents a systematic allocation of the cost
of a physical facility over time.

There are various methods of computing depreciation which are acceptable to the
U.S. Internal Revenue Service. The different methods of computing depreciation
have different effects on the streams of annual depreciation charges, and hence on
the stream of taxable income and taxes paid. Let P be the cost of an asset, S its
estimated salvage value, and N the estimated useful life (depreciable life) in years.
Furthermore, let Dt denote the depreciation amount in year t, Tt denote the
accumulated depreciation up to year t, and Bt denote the book value of the asset at
the end of year t, where t=1,2,..., or n refers to the particular year under
consideration. Then,

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(6.11)

and
(6.12)

The depreciation methods most commonly used to compute Dt and Bt are the
straight line method, sum-of-the-years'-digits methods, and the double declining
balanced method. The U.S. Internal Revenue Service provides tables of acceptable
depreciable schedules using these methods. Under straight line depreciation, the net
depreciable value resulting from the cost of the facility less salvage value is
allocated uniformly to each year of the estimated useful life. Under the sum-of-the-
year's-digits (SOYD) method, the annual depreciation allowance is obtained by
multiplying the net depreciable value multiplied by a fraction, which has as its
numerator the number of years of remaining useful life and its denominator the sum
of all the digits from 1 to n. The annual depreciation allowance under the double
declining balance method is obtained by multiplying the book value of the previous
year by a constant depreciation rate 2/n.

To consider tax effects in project evaluation, the most direct approach is to estimate
the after-tax cash flow and then apply an evaluation method such as the net present
value method. Since projects are often financed by internal funds representing the
overall equity-debt mix of the entire corporation, the deductibility of interest on
debt may be considered on a corporate-wide basis. For specific project financing
from internal funds, let after-tax cash flow in year t be Yt. Then, for t=0,1,2,...,n,

(6.13)

where At is the net revenue before tax in year t, Dt is the depreciation allowable for
year t and Xt is the marginal corporate income tax rate in year t.

Besides corporate income taxes, there are other provisions in the federal income tax
laws that affect facility investments, such as tax credits for low-income housing.
Since the tax laws are revised periodically, the estimation of tax liability in the
future can only be approximate.

Example 6-2: Effects of Taxes on Investment

A company plans to invest $55,000 in a piece of equipment which is expected to

produce a uniform annual net revenue before tax of $15,000 over the next five
years. The equipment has a salvage value of $5,000 at the end of 5 years and the
depreciation allowance is computed on the basis of the straight line depreciation
method. The marginal income tax rate for this company is 34%, and there is no
expectation of inflation. If the after-tax MARR specified by the company is 8%,

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determine whether the proposed investment is worthwhile, assuming that the
investment will be financed by internal funds.

Using Equations (6.11) and (6.13), the after-tax cash flow can be computed as
shown in Table 6-2. Then, the net present value discounted at 8% is obtained from
Equation (6.5) as follows:

The positive result indicates that the project is worthwhile.

TABLE 6-2 After-Tax Cash Flow Computation

Before-tax Cash Straight-line Taxable Income After-Tax Cash-
Year Flow Depreciation Income Tax Flow
t At Dt At-Dt Xt(At-Dt) Yt
0 - $55,000 - $55,000
1-5 each + $15,000 $10,000 $5,000 $1,700 + $13,300
5 only + $5,000 + $5,000

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6.8 Price Level Changes: Inflation and Deflation

In the economic evaluation of investment proposals, two approaches may be used
to reflect the effects of future price level changes due to inflation or deflation. The
differences between the two approaches are primarily philosophical and can be
succinctly stated as follows:

1. The constant dollar approach. The investor wants a specified MARR

excluding inflation. Consequently, the cash flows should be expressed in
terms of base-year or constant dollars, and a discount rate excluding inflation
should be used in computing the net present value.
2. The inflated dollar approach. The investor includes an inflation component
in the specified MARR. Hence, the cash flows should be expressed in terms
of then-current or inflated dollars, and a discount rate including inflation
should be used in computing the net present value.

If these approaches are applied correctly, they will lead to identical results.

Let i be the discount rate excluding inflation, i' be the discount rate including
inflation, and j be the annual inflation rate. Then,

203
(6.14)

and

(6.15)

When the inflation rate j is small, these relations can be approximated by

(6.16)

Note that inflation over time has a compounding effect on the price levels in
various periods, as discussed in connection with the cost indices in Chapter 5.

If At denotes the cash flow in year t expressed in terms of constant (base year)
dollars, and A't denotes the cash flow in year t expressed in terms of inflated (then-
current) dollars, then

(6.17)

or

(6.18)

It can be shown that the results from these two equations are identical.
Furthermore, the relationship applies to after-tax cash flow as well as to before-tax
cash flow by replacing At and A't with Yt and Y't respectively in Equations (6.17)
and (6.18).

Example 6-3: Effects of Inflation

Suppose that, in the previous example, the inflation expectation is 5% per year, and
the after-tax MARR specified by the company is 8% excluding inflation.
Determine whether the investment is worthwhile.

In this case, the before-tax cash flow At in terms of constant dollars at base year 0 is
inflated at j = 5% to then-current dollars A't for the computation of the taxable

204
income (A't - Dt) and income taxes. The resulting after-tax flow Y't in terms of then-
current dollars is converted back to constant dollars. That is, for Xt = 34% and Dt =
$10,000. The annual depreciation charges Dt are not inflated to current dollars in
conformity with the practice recommended by the U.S. Internal Revenue Service.
Thus:

A't = At(1 + j)t = At(1 + 0.05)t

Y't = A't - Xt(A't - Dt) = A't - (34%)(A't - $10,000)
Yt = Y't(1 + j) = Y't(1 + 0.05)t
t

The detailed computation of the after-tax cash flow is recorded in Table 6-3. The
net present value discounted at 8% excluding inflation is obtained by substituting
Yt for At in Eq. (6.17). Hence,

[NPV]8%) = -55,000 + (13,138)(P|F, 8%, 1) + (12,985)(P|F, 8%, 2) + (12,837)(P|F,

8%, 3)
+ (12,697)(P|F, 8%, 4) + (12,564 + 5,000)(P|F, 8%, 5) = -$227

With 5% inflation, the investment is no longer worthwhile because the value of the
depreciation tax deduction is not increased to match the inflation rate.

TABLE 6-3 After-Tax Cash Flow Including Inflation

Current $ depreciation
Dt Current $ after depreciation
A't-Dt Current $ income tax
Xt(A't-Dt) Current $ A-Tax CF
Y't Constant $ A-Tax CF
Yt
Time
t
0
1
2
3
4
5
5 Const
ant $ B-
Tax -$55,000 -$55,000
CF +15,000 +$55,000 -$55,000 +13,138
At Curr +15,000 +15,750 $10,000 $5,750 $1,955 +13,795 +12,985
ent $ B- +15,000 16,540 10,000 6,540 2,224 +14,316 +12,837
Tax +15,000 17,365 10,000 7,365 2,504 +14,861 +12,697
CF +15,000 18,233 10,000 8,233 2,799 +15,434 +12,564
A't +5,000 19,145 10,000 9,145 3,109 +16,036 +5,000

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Note: B-Tax CF refers to Before-Tax Cash Flow;
A-Tax CF refers to After-Tax Cash Flow

Example 6-4: Inflation and the Boston Central Artery Project

The cost of major construction projects are often reported as simply the sum of all
expenses, no matter what year the cost was incurred. For projects extending over a
lengthy period of time, this practice can combine amounts of considerably different
inherent values. A good example is the Boston Central Artery/Tunnel Project, a
very large project to construct or re-locate two Interstate highways within the city
of Boston.

In Table 6-4, we show one estimate of the annual expenditures for the Central
Artery/Tunnel from 1986 to 2006 in millions of dollars, appearing in the column
labelled "Expenses ($ M)." We also show estimates of construction price inflation
in the Boston area for the same period, one based on 1982 dollars (so the price
index equals 100 in 1982) and one on 2002 dollars. If the dollar expenditures are
added up, the total project cost is $ 14.6 Billion dollars, which is how the project
cost is often reported in summary documents. However, if the cost is calculated in
constant 1982 dollars (when the original project cost estimate was developed for
planning purposes), the project cost would be only $ 8.4 Billion, with price
inflation increasing expenses by $ 6.3 Billion. As with cost indices discussed in
Chapter 5, the conversion to 1982 $ is accomplished by dividing by the 1982 price
index for that year and then multiplying by 100 (the 1982 price index value). If the
cost is calculated in constant 2002 dollars, the project cost increases to $ 15.8
Billion. When costs are incurred can significantly affect project expenses!

TABLE 6-4 Cash Flows for the Boston Central Artery/Tunnel Project
Price Price Project Project
Year Index Index Expenses Expenses Project Expenses
t 1982 $ 2002 $ ($ M) (1982 $ M) (2002 $ M)
1982 100 53
1983 104 55
1984 111 59
1985 118 62
1986 122 65 33,000 27,000 51,000
1987 123 65 82,000 67,000 126,000
1988 130 69 131,000 101,000 190,000
1989 134 71 164,000 122,000 230,000
1990 140 74 214,000 153,000 289,000
1991 144 76 197,000 137,000 258,000
1992 146 77 246,000 169,000 318,000
1993 154 82 574,000 372,000 703,000
1994 165 88 854,000 517,000 975,000
1995 165 88 852,000 515,000 973,000
1996 165 87 764,000 464,000 877,000

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1997 175 93 1,206,000 687,000 1,297,000
1998 172 91 1,470,000 853,000 1,609,000
1999 176 94 1,523,000 863,000 1,629,000
2000 181 96 1,329,000 735,000 1,387,000
2001 183 97 1,246,000 682,000 1,288,000
2002 189 100 1,272,000 674,000 1,272,000
2003 195 103 1,115,000 572,000 1,079,000
2004 202 107 779,000 386,000 729,000
2005 208 110 441,000 212,000 399,000
2006 215 114 133,000 62,000 117,000

Sum 14,625,000 8,370,000 15,797,000

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6.9 Uncertainty and Risk

Since future events are always uncertain, all estimates of costs and benefits used in
economic evaluation involve a degree of uncertainty. Probabilistic methods are
often used in decision analysis to determine expected costs and benefits as well as
to assess the degree of risk in particular projects.

In estimating benefits and costs, it is common to attempt to obtain the expected or

average values of these quantities depending upon the different events which might
occur. Statistical techniques such as regression models can be used directly in this
regard to provide forecasts of average values. Alternatively, the benefits and costs
associated with different events can be estimated and the expected benefits and
costs calculated as the sum over all possible events of the resulting benefits and
costs multiplied by the probability of occurrence of a particular event:

(6.19)

and

(6.20)

where q = 1,....,m represents possible events, (Bt|q) and (Ct|q) are benefits and costs
respectively in period t due to the occurrence of q, Pr{q} is the probability that q
occurs, and E[Bt] and E[Ct] are respectively expected benefit and cost in period t.
Hence, the expected net benefit in period t is given by:

(6.21)

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For example, the average cost of a facility in an earthquake prone site might be
calculated as the sum of the cost of operation under normal conditions (multiplied
by the probability of no earthquake) plus the cost of operation after an earthquake
(multiplied by the probability of an earthquake). Expected benefits and costs can be
used directly in the cash flow calculations described earlier.

In formulating objectives, some organizations wish to avoid risk so as to avoid the

possibility of losses. In effect, a risk avoiding organization might select a project
with lower expected profit or net social benefit as long as it had a lower risk of
losses. This preference results in a risk premium or higher desired profit for risky
projects. A rough method of representing a risk premium is to make the desired
MARR higher for risky projects. Let rfbe the risk free market rate of interest as
represented by the average rate of return of a safe investment such as U.S.
government bonds. However, U.S. government bonds do not protect from
inflationary changes or exchange rate fluctuations, but only insure that the principal
and interest will be repaid. Let rp be the risk premium reflecting an adjustment of
the rate of return for the perceived risk. Then, the risk-adjusted rate of return r is
given by:

(6.22)

In using the risk-adjusted rate of return r to compute the net present value of an
estimated net cash flow At (t = 0, 1, 2, ..., n) over n years, it is tacitly assumed that
the values of At become more uncertain as time goes on. That is:

(6.23)

More directly, a decision maker may be confronted with the subject choice among
alternatives with different expected benefits of levels of risk such that at a given
period t, the decision maker is willing to exchange an uncertain At with a smaller
but certain return atAt where at is less than one. Consider the decision tree in Figure
6-2 in which the decision maker is confronted with a choice between the certain
return of atAt and a gamble with possible outcomes (At;)q and respective
probabilities Pr{q} for q = 1,2,...,m. Then, the net present value for the series of
"certainty equivalents" over n years may be computed on the basis of the risk free
rate. Hence:

(6.24)

208
Note that if rfrp is negligible in comparison with r, then

(1 + rf)(1 + rp) = 1 +rf + rp + rfrp = 1 + r

Hence, for Eq. (6.23)
At(1 + r)-t = (atAt/at)(1 + rf)-t(1 + rp)-t =[(atAt)(1 + rf)-t][(1 + rp)-t/at]

If at = (1 + rp)-t for t = 1,2,...,n, then Eqs. (6.23) and (6.24) will be identical. Hence,
the use of the risk-adjusted rate r for computing NPV has the same effect as
accepting at = (1 + rp)-t as a "certainty equivalent" factor in adjusting the estimated
cash flow over time.

Figure 6-2 Determination of a Certainty Equivalent Value

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6.10 Effects of Financing on Project Selection

Selection of the best design and financing plans for capital projects is typically
done separately and sequentially. Three approaches to facility investment planning
most often adopted by an organization are:

209
 1. Need or demand driven: Public capital investments are defined and debated
in terms of an absolute "need" for particular facilities or services. With a pre-
defined "need," design and financing analysis then proceed separately. Even
when investments are made on the basis of a demand or revenue analysis of
the market, the separation of design and financing analysis is still prevalent.
2. Design driven: Designs are generated, analyzed and approved prior to the
investigation of financing alternatives, because projects are approved first
and only then programmed for eventual funding.
3. Finance driven: The process of developing a facility within a particular
budget target is finance-driven since the budget is formulated prior to the
final design. It is a common procedure in private developments and
increasingly used for public projects.

Typically, different individuals or divisions of an organization conduct the analysis

for the operating and financing processes. Financing alternatives are sometimes not
examined at all since a single mechanism is universally adopted. An example of a
single financing plan in the public sector is the use of pay-as-you-go highway trust
funds. However, the importance of financial analysis is increasing with the increase
of private ownership and private participation in the financing of public projects.
The availability of a broad spectrum of new financing instruments has accentuated
the needs for better financial analysis in connection with capital investments in
both the public and private sectors. While simultaneous assessment of all design
and financing alternatives is not always essential, more communication of
information between the two evaluation processes would be advantageous in order
to avoid the selection of inferior alternatives.

There is an ever increasing variety of borrowing mechanisms available. First, the

extent to which borrowing is tied to a particular project or asset may be varied.
Loans backed by specific, tangible and fungible assets and with restrictions on that
asset's use are regarded as less risky. In contrast, specific project finance may be
more costly to arrange due to transactions costs than is general corporate or
government borrowing. Also, backing by the full good faith and credit of an
organization is considered less risky than investments backed by generally
immovable assets. Second, the options of fixed versus variable rate borrowing are
available. Third, the repayment schedule and time horizon of borrowing may be
varied. A detailed discussion of financing of constructed facilities will be deferred
until the next chapter.

As a general rule, it is advisable to borrow as little as possible when borrowing

rates exceed the minimum attractive rate of return. Equity or pay-as-you-go
financing may be desirable in this case. It is generally preferable to obtain lower
borrowing rates, unless borrowing associated with lower rates requires substantial
transaction costs or reduces the flexibility for repayment and refinancing. In the
public sector, it may be that increasing taxes or user charges to reduce borrowing
involves economic costs in excess of the benefits of reduced borrowing costs of

210
borrowed funds. Furthermore, since cash flow analysis is typically conducted on
the basis of constant dollars and loan agreements are made with respect to current
dollars, removing the effects of inflation will reduce the cost of borrowing. Finally,
deferring investments until pay-as-you-go or equity financing are available may
unduly defer the benefits of new investments.

It is difficult to conclude unambiguously that one financing mechanism is always

superior to others. Consequently, evaluating alternative financing mechanisms is an
important component of the investment analysis procedure. One possible approach
to simultaneously considering design and financing alternatives is to consider each
combination of design and financing options as a specific, mutually exclusive
alternative. The cash flow of this combined alternative would be the sum of the
economic or operating cash flow (assuming equity financing) and the financial cash
flow over the planning horizon.

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6.11 Combined Effects of Operating and Financing Cash

Flows
A general approach for obtaining the combined effects of operating and financing
cash flows of a project is to make use of the additive property of net present values
by calculating an adjusted net present value. The adjusted net present value (APV)
is the sum of the net present value (NPV) of the operating cash flow plus the net
present value of the financial cash flow due to borrowing or raising capital (FPV).
Thus,

(6.25)

where each function is evaluated at i=MARR if both the operating and the
financing cash flows have the same degree of risk or if the risks are taken care of in
other ways such as by the use of certainty equivalents. Then, project selection
involving both design and financing alternatives is accomplished by selecting the
combination which has the highest positive adjusted present value. The use of this
adjusted net present value method will result in the same selection as an evaluation
based on the net present value obtained from the combined cash flow of each
alternative combination directly.

To be specific, let At be the net operating cash flow, be the net financial cash
flow resulting from debt financing, and AAt be the combined net cash flow, all for
year t before tax. Then:

211
(6.26)

Similarly, let and YYt be the corresponding cash flows after tax such that:

(6.27)

The tax shields for interest on borrowing (for t = 1, 2, ..., n) are usually given by

(6.28)

where It is the interest paid in year t and Xt is the marginal corporate income tax
rate in year t. In view of Eqs. (6.13), (6.27) and (6.28), we obtain

(6.29)

When MARR = i is applied to both the operating and the financial cash flows in
Eqs. (6.13) and (6.28), respectively, in computing the net present values, the
combined effect will be the same as the net present value obtained by applying
MARR = i to the combined cash flow in Eq. (6.29).

In many instances, a risk premium related to the specified type of operation is

added to the MARR for discounting the operating cash flow. On the other hand, the
MARR for discounting the financial cash flow for borrowing is often regarded as
relatively risk-free because debtors or holders of corporate bonds must be paid first
before stockholders in case financial difficulties are encountered by a corporation.
Then, the adjusted net present value is given by

(6.30)

where NPV is discounted at r and FPV is obtained from the rf rate. Note that the net
present value of the financial cash flow includes not only tax shields for interest on

212
loans and other forms of government subsidy, but also on transactions costs such as
those for legal and financial services associated with issuing new bonds or stocks.

The evaluation of combined alternatives based on the adjusted net present value
method should also be performed in dollar amounts which either consistently
include or remove the effects of inflation. The MARR value used would reflect the
inclusion or exclusion of inflation accordingly. Furthermore, it is preferable to use
after-tax cash flows in the evaluation of projects for private firms since different
designs and financing alternatives are likely to have quite different implications for
tax liabilities and tax shields.

In theory, the corporate finance process does not necessarily require a different
approach than that of the APV method discussed above. Rather than considering
single projects in isolation, groups or sets of projects along with financing
alternatives can be evaluated. The evaluation process would be to select that group
of operating and financing plans which has the highest total APV. Unfortunately,
the number of possible combinations to evaluate can become very large even
though many combinations can be rapidly eliminated in practice because they are
clearly inferior. More commonly, heuristic approaches are developed such as
choosing projects with the highest benefit/cost ratio within a particular budget or
financial constraint. These heuristic schemes will often involve the separation of
the financing and design alternative evaluation. The typical result is design-driven
or finance-driven planning in which one or the other process is conducted first.

Example 6-5: Combined Effects of Operating and Financing Plans

A public agency plans to construct a facility and is considering two design

alternatives with different capacities. The operating net cash flows for both
alternatives over a planning horizon of 5 years are shown in Table 6-4. For each
design alternative, the project can be financed either through overdraft on bank
credit or by issuing bonds spanning over the 5-year period, and the cash flow for
each financing alternative is also shown in Table 6-4. The public agency has
specified a MARR of 10% for discounting the operating and financing cash flows
for this project. Determine the best combination of design and financing plan if
(a) a design is selected before financing plans are considered, or
(b) the decision is made simultaneously rather than sequentially.
The net present values (NPV) of all cash flows can be computed by Eq.(6.5), and
the results are given at the bottom of Table 6-4. The adjusted net present value
(APV) combining the operating cash flow of each design and an appropriate
financing is obtained according to Eq. (6.25), and the results are also tabulated at
the bottom of Table 6-4.

Under condition (a), design alternative 2 will be selected since NPV = $767,000 is
the higher value when only operating cash flows are considered. Subsequently,

213
bonds financing will be chosen because APV = $466,000 indicates that it is the best
financing plan for design alternative 2.

Under condition (b), however, the choice will be based on the highest value of
APV, i.e., APV = $484,000 for design alternative one in combination will overdraft
financing. Thus, the simultaneous decision approach will yield the best results.

TABLE 6-5 Illustration of Different Design and Financing Alternatives (in $ thousands)
Design Alternative One Design Alternative Two
Operating Overdraft Bond Operating Overdraft Bond
Year Cash Flow Financing Financing Cash Flow Financing Financing
0 -$1,000 $1,000 $3,653 $-2,500 $2,500 $3,805
1 -2,500 2,500 -418 -1,000 1,000 -435
2 1,000 -1,000 -418 1,000 -1,000 -435
3 1,500 -1,500 -418 1,500 -1,500 -435
4 1,500 -1,500 -418 1,500 -1,500 -435
5 1,700 -921 -4,217 1,930 -1,254 -4,392
NPV or
FPV at 761 -277 -290 767 -347 -301
10%
APV =
NPV + 484 471 420 466
FPV

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6.12 Public versus Private Ownership of Facilities

In recent years, various organizational ownership schemes have been proposed to
raise the level of investment in constructed facilities. For example, independent
authorities are assuming responsibility for some water and sewer systems, while
private entrepreneurs are taking over the ownership of public buildings such as
stadiums and convention centers in joint ventures with local governments. Such
ownership arrangements not only can generate the capital for new facilities, but
also will influence the management of the construction and operation of these
facilities. In this section, we shall review some of these implications.

A particular organizational arrangement or financial scheme is not necessarily

superior to all others in each case. Even for similar facilities, these arrangements
and schemes may differ from place to place or over time. For example, U.S. water
supply systems are owned and operated both by relatively large and small
organizations in either the private or public sector. Modern portfolio theory suggest
that there may be advantages in using a variety of financial schemes to spread risks.

214
Similarly, small or large organizations may have different relative advantages with
respect to personnel training, innovation or other activities.

Differences in Required Rates of Return

A basic difference between public and private ownership of facilities is that private
organizations are motivated by the expectation of profits in making capital
investments. Consequently, private firms have a higher minimum attractive rate of
return (MARR) on investments than do public agencies. The MARR represents the
desired return or profit for making capital investments. Furthermore, private firms
often must pay a higher interest rate for borrowing than public agencies because of
the tax exempt or otherwise subsidized bonds available to public agencies.
International loans also offer subsidized interest rates to qualified agencies or
projects in many cases. With higher required rates of return, we expect that private
firms will require greater receipts than would a public agency to make a particular
investment desirable.

In addition to different minimum attractive rates of return, there is also an

important distinction between public and private organizations with respect to their
evaluation of investment benefits. For private firms, the returns and benefits to
cover costs and provide profit are monetary revenues. In contrast, public agencies
often consider total social benefits in evaluating projects. Total social benefits
include monetary user payments plus users' surplus (e.g., the value received less
costs incurred by users), external benefits (e.g., benefits to local businesses or
property owners) and nonquantifiable factors (e.g., psychological support,
unemployment relief, etc.). Generally, total social benefits will exceed monetary
revenues.

While these different valuations of benefits may lead to radically different results
with respect to the extent of benefits associated with an investment, they do not
necessarily require public agencies to undertake such investments directly. First,
many public enterprises must fund their investments and operating expenses from
user fees. Most public utilities fall into this category, and the importance of user fee
financing is increasing for many civil works such as waterways. With user fee
financing, the required returns for the public and private firms to undertake the
aforementioned investment are, in fact, limited to monetary revenues. As a second
point, it is always possible for a public agency to contract with a private firm to
undertake a particular project.

All other things being equal, we expect that private firms will require larger returns
from a particular investment than would a public agency. From the users or
taxpayers point of view, this implies that total payments would be higher to private
firms for identical services. However, there are a number of mitigating factors to
counterbalance this disadvantage for private firms.

215
Tax Implications of Public Versus Private Organizations

Another difference between public and private facility owners is in their relative
liability for taxes. Public entities are often exempt from taxes of various kinds,
whereas private facility owners incur a variety of income, property and excise
taxes. However, these private tax liabilities can be offset, at least in part, by tax
deductions of various kinds.

For private firms, income taxes represent a significant cost of operation. However,
taxable income is based on the gross revenues less all expenses and allowable
deductions as permitted by the prevalent tax laws and regulations. The most
significant allowable deductions are depreciation and interest. By selecting the
method of depreciation and the financing plan which are most favorable, a firm can
exert a certain degree of control on its taxable income and, thus, its income tax.

Another form of relief in tax liability is the tax credit which allows a direct
deduction for income tax purposes of a small percentage of the value of certain
newly acquired assets. Although the provisions for investment tax credit for
physical facilities and equipment had been introduced at different times in the US
federal tax code, they were eliminated in the 1986 Tax Reformation Act except a
tax credit for low-income housing.

Of course, a firm must have profits to take direct advantage of such tax shields, i.e.,
tax deductions only reduce tax liabilities if before-tax profits exist. In many cases,
investments in constructed facilities have net outlays or losses in the early years of
construction. Generally, these losses in early years can be offset against profits
occurred elsewhere or later in time. Without such offsetting profits, losses can be
carried forward by the firm or merged with other firms' profits, but these
mechanisms will not be reviewed here.

Effects of Financing Plans

Major investments in constructed facilities typically rely upon borrowed funds for a
large portion of the required capital investments. For private organizations, these
borrowed funds can be useful for leverage to achieve a higher return on the
organizations' own capital investment.

For public organizations, borrowing costs which are larger than the MARR results
in increased "cost" and higher required receipts. Incurring these costs may be
essential if the investment funds are not otherwise available: capital funds must
come from somewhere. But it is not unusual for the borrowing rate to exceed the
MARR for public organizations. In this case, reducing the amount of borrowing
lowers costs, whereas increasing borrowing lowers costs whenever the MARR is
greater than the borrowing rate.

216
Although private organizations generally require a higher rate of return than do
public bodies (so that the required receipts to make the investment desirable are
higher for the private organization than for the public body), consideration of tax
shields and introduction of a suitable financing plan may reduce this difference.
The relative levels of the MARR for each group and their borrowing rates are
critical in this calculation.

Effects of Capital Grant Subsidies

An important element in public investments is the availability of capital grant

subsidies from higher levels of government. For example, interstate highway
construction is eligible for federal capital grants for up to 90% of the cost. Other
programs have different matching amounts, with 50/50 matching grants currently
available for wastewater treatment plants and various categories of traffic systems
improvement in the U.S. These capital grants are usually made available solely for
public bodies and for designated purposes.

While the availability of capital grant subsidies reduces the local cost of projects,
the timing of investment can also be affected. In particular, public subsidies may be
delayed or spread over a longer time period because of limited funds. To the extent
that (discounted) benefits exceed costs for particular benefits, these funding delays
can be costly. Consequently, private financing and investment may be a desirable
alternative, even if some subsidy funds are available.

Implications for Design and Construction

Different perspectives and financial considerations also may have implications for
design and construction choices. For example, an important class of design
decisions arises relative to the trade-off between capital and operating costs. It is
often the case that initial investment or construction costs can be reduced, but at the
expense of a higher operating costs or more frequent and extensive rehabilitation or
repair expenditures. It is this trade-off which has led to the consideration of "life
cycle costs" of alternative designs. The financial schemes reviewed earlier can
profoundly effect such evaluations.

For financial reasons, it would often be advantageous for a public body to select a
more capital intensive alternative which would receive a larger capital subsidy and,
thereby, reduce the project's local costs. In effect, the capital grant subsidy would
distort the trade-off between capital and operating costs in favor of more capital
intensive projects.

The various tax and financing considerations will also affect the relative merits of
relatively capital intensive projects. For example, as the borrowing rate increases,
more capital intensive alternatives become less attractive. Tax provisions such as
the investment tax credit or accelerated depreciation are intended to stimulate

217
investment and thereby make more capital intensive projects relatively more
desirable. In contrast, a higher minimum attractive rate of return tends to make
more capital intensive projects less attractive.

Back to top

6.13 Economic Evaluation of Different Forms of

Ownership
While it is difficult to conclude definitely that one or another organizational or
financial arrangement is always superior, different organizations have systematic
implications for the ways in which constructed facilities are financed, designed and
constructed. Moreover, the selection of alternative investments for constructed
facilities is likely to be affected by the type and scope of the decision-making
organization.

As an example of the perspectives of public and private organizations, consider the

potential investment on a constructed facility with a projected useful life of n years.
Let t = 0 be the beginning of the planning horizon and t = 1, 2, ... n denote the end
of each of the subsequent years. Furthermore, let Co be the cost of acquiring the
facility at t = 0, and Ct be the cost of operation in year t. Then, the net receipts A t in
year t is given by At = Bt - Ct in which Bt is the benefit in year t and At may be
positive or negative for t = 0, 1, 2, ..., n.

Let the minimum attractive rate of return (MARR) for the owner of the facility be
denoted by i. Then, the net present value (NPV) of a project as represented by the
net cash flow discounted to the present time is given by

(6.31)

Then, a project is acceptable if NPV 0. When the annual gross receipt is uniform,
i.e., Bt = B for t = 1, 2, ..., n and B0 = 0, then, for NPV = 0:

(6.32)

Thus, the minimum uniform annual gross receipt B which makes the project
economically acceptable can be determined from Equation (6.32), once the
acquisition and operation costs Ct of the facility are known and the MARR is
specified.

218
Example 6-6: Different MARRs for Public and Private Organizations

For the facility cost stream of a potential investment with n = 7 in Table 6-5, the
required uniform annual gross receipts B are different for public and private
ownerships since these two types of organizations usually choose different values
of MARR. With a given value of MARR = i in each case, the value of B can be
obtained from Eq. (6.32). With a MARR of 10%, a public agency requires at least
B = $184,000. By contrast, a private firm using a 20% MARR before tax while
neglecting other effects such as depreciation and tax deduction would require at
least B = $219,000. Then, according to Eq. (6.31), the gross receipt streams for
both public and private ownerships in Table 6-5 will satisfy the condition NPV = 0
when each of them is netted from the cost stream and discounted at the appropriate
value of MARR, i.e., 10% for a public agency and 20% (before tax) for a private
firm. Thus, this case suggests that public provision of the facility has lower user
costs.

TABLE 6-6 Required Uniform Annual Gross Receipts for Public and
Private Ownership of a Facility (in $ thousands)
Public Ownership Private Ownership
Facility Gross Receipt, Net Receipt Gross Receipt, Net Receipt
Year t cost, Ct Bt At=Bt - Ct Bt At=Bt - Ct
0 $500 $0 -$500 $0 -$500
1 76 184 108 219 143
2 78 184 106 219 141
3 80 184 104 219 139
4 82 184 102 219 137
5 84 184 100 219 135
6 86 184 98 219 133
7 88 184 96 219 131

Example 6-7: Effects of Depreciation and Tax Shields for Private Firms

Using the same data as in Example 6-6, we now consider the effects of depreciation
and tax deduction for private firms. Suppose that the marginal tax rate of the firm is
34% in each year of operation, and losses can always be offset by company-wide
profits. Suppose further that the salvage value of the facility is zero at the end of
seven years so that the entire amount of cost can be depreciated by means of the
sum-of-the-years'-digits (SOYD) method. Thus, for the sum of digits 1 through 7
equal to 28, the depreciation allowances for years 1 to 7 are respectively 7/28, 6/28,
..., 1/28 of the total depreciable value of $ 500,000, and the results are recorded in
column 3 of Table 6-6. For a uniform annual gross receipt B = $219,000, the net
receipt before tax in Column 6 of Table 6-5 in Example 6-5 can be used as the
starting point for computing the after-tax cash flow according to Equation (6.13)
which is carried out step-by-step in Table 6-6. (Dollar amounts are given to the

219
nearest $1,000). By trial and error, it is found that an after-tax MARR = 14.5% will
produce a zero value for the net present value of the discounted after-tax flow at t =
0. In other words, the required uniform annual gross receipt for this project at
14.5% MARR after tax is also B = $219,000. It means that the MARR of this
private firm must specify a 20% MARR before tax in order to receive the
equivalent of 14.5% MARR after tax.
TABLE6-7 Effects of Depreciation and Tax Deductions for Private
Ownership in a Facility (in $ thousands)
Net After-tax
Receipt Income Cash Flow
Before- Depreciation Taxable Tax
tax (SOYD) Income Xt(At - < width="25"
Year t At Dt (At - Dt) Dt) height="26">
0 -$500 $0 $0 $0 -$500
1 143 125 18 6 137
2 141 107 34 12 129
3 139 89 50 17 122
4 137 71 66 22 115
5 135 54 81 28 107
6 133 36 97 33 100
7 131 18 113 38 93

Example 6-8: Effects of Borrowing on Public Agencies

Suppose that the gross uniform annual receipt for public ownership is B = $190,000
instead of $184,000 for the facility with cost stream given in Column 2 of Table 6-
5. Suppose further that the public agency must borrow $400,000 (80% of the
facility cost) at 12% annual interest, resulting in an annual uniform payment of
$88,000 for the subsequent seven years. This information has been summarized in
Table 6-7. The use of borrowed funds to finance a facility is referred to as debt
financing or leveraged financing, and the combined cash flow resulting from
operating and financial cash flows is referred to as the levered cash flow.

To the net receipt At in Column 4 of Table 6-7, which has been obtained from a
uniform annual gross receipt of $190,000, we add the financial cash flow ,
which included a loan of $400,000 with an annual repayment of $88,000
corresponding to an interest rate of 12%. Then the resulting combined cash flow
AAt as computed according to Equation (6.26) is shown in column 6 of Table 6-7.
Note that for a loan at 12% interest, the net present value of the combined cash
flow AAt is zero when discounted at a 10% MARR for the public agency. This is
not a coincidence, but several values of B have been tried until B = $190,000 is
found to satisfy NPV = 0 at 10% MARR. Hence, the minimum required uniform
annual gross receipt is B = $190,000.

220
 TABLE 6-8 Effects of Borrowing on a Publicly Owned Facility (in $
thousands)
Loan and
Gross Facility Net receipt payment Combined cash flow
Year receipt cost (no loan) (12% interest) (12% interest)
t Bt Ct At AAt
0 $0 $500 -$500 +$400 -$100
1 190 76 114 -88 26
2 190 78 112 -88 24
3 190 80 110 -88 22
4 190 82 108 -88 20
5 190 84 106 -88 18
6 190 86 104 -88 16
7 190 88 102 -88 14

Example 6-9: Effects of Leverage and Tax Shields for Private Organizations

Suppose that the uniform annual gross receipt for a private firm is also B =
$190,000 (the same as that for the public agency in Example 6-7). The salvage
value of the facility is zero at the end of seven years so that the entire amount of
cost can be depreciated by means of the sum-of-the-years'-digit (SOYD) method.
The marginal tax rate of the firm is 34% in each year of operation, and losses can
always be offset by company-wide profits. Suppose further that the firm must
borrow $400,000 (80% of the facility cost) at a 12% annual interest, resulting in an
annual uniform payment of $88,000 for the subsequent seven years. The interest
charge each year can be computed as 12% of the remaining balance of the loan in
the previous year, and the interest charge is deductible from the tax liability.

For B = $190,000 and a facility cost stream identical to that in Example 6-7, the net
receipts before tax At (operating cash flow with no loan) in Table 6-7 can be used
as the starting point for analyzing the effects of financial leverage through
borrowing. Thus, column 4 of Table 6-7 is reproduced in column 2 of Table 6-8.

The computation of the after-tax cash flow of the private firm including the effects
of tax shields for interest is carried out in Table 6-8. The financial - cash stream
in Column 4 of Table 6-8 indicates a loan of $400,000 which is secured at t = 0 for
an annual interest of 12%, and results in a series of uniform annual payments of
$88,000 in order to repay the principal and interest. The levered after-tax cash flow
YYt can be obtained by Eq. (6.29), using the same investment credit, depreciation
method and tax rate, and is recorded in Column 7 of Table 6-8. Since the net
present value of YYt in Column 7 of Table 6-8 discounted at 14.5% happens to be
zero, the minimum required uniform annual gross receipt for the potential
investment is $190,000. By borrowing $400,000 (80% of the facility cost) at 12%
annual interest, the investment becomes more attractive to the private firm. This is

221
expected because of the tax shield for the interest and the 12% borrowing rate
which is lower than the 14.5% MARR after-tax for the firm.

TABLE 6-9 Effects of Financial Leverage and Tax Shields on Private

Ownership of a Facility (in $ thousands)
Net
Receipt Income
Before Loan and Tax After Tax
Tax Depreciation Scheduled Interest (34% rate) Cash Flow
Year (no loan) (SOYD) Payment On Loan X (A - (levered)
t t
t At Dt It Dt - It) YYt
0 -$500 $0 $400 $0 $0 -$100
1 114 125 -88 48 -19 45
2 112 107 -88 43 -13 37
3 110 89 -88 38 -6 28
4 108 71 -88 32 2 18
5 106 54 -88 25 9 9
6 104 36 -88 18 17 -1
7 102 18 -88 9 26 -12

Example 6-10: Comparison of Public and Private Ownership.

In each of the analyses in Examples 6-5 through 6-8, a minimum required uniform
annual gross receipt B is computed for each given condition whether the owner is a
public agency or a private firm. By finding the value of B which will lead to NPV =
0 for the specified MARR for the organization in each case, various organizational
effects with or without borrowing can be analyzed. The results are summarized in
Table 6-9 for comparison. In this example, public ownership with a 80% loan and a
10% MARR has the same required benefit as private ownership with an identical
80% loan and a 14.5% after-tax MARR.
TABLE 6-10 Summary effects of Financial Leverage and Tax Shields on
Private Ownership
Organizational Financial Minimum benefit
condition arrangement required
Public, no tax No loan $184,000
(MARR = 10%) 80% loan at 12% interest 190,000
Private, before tax No loan 219,000
(MARR = 20%) 219,000
Private, after tax No loan 219,000
(MARR = 14.5%) 80% loan at 12% interest 190,000

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6.14 References

222
 1. Au, T., "Profit Measures and Methods of Economic Analysis for Capital
Project Selection," ASCE Journal of Management in Engineering, Vol. 4,
No. 3, 1988.
2. Au, T. and T. P. Au, Engineering Economics for Capital Investment
Analysis, Allyn and Bacon, Newton, MA, 1983.
3. Bierman, H., Jr., and S. Smidt, The Capital Budgeting Decision, 5th Ed.,
Macmillan, New York, 1984.
4. Brealey, R. and S. Myers, Principles of Corporate Finance, Second Edition,
McGraw-Hill, New York, 1984.
5. Edwards, W.C. and J.F. Wong, "A Computer Model to Estimate Capital and
Operating Costs," Cost Engineering, Vol. 29, No. 10, 1987, pp. 15-21.
6. Hendrickson, C. and T. Au, "Private versus Public Ownership of
Constructed Facilities," ASCE Journal of Management in Engineering, Vol.
1, No. 3, 1985, pp. 119-131.
7. Wohl, M. and C. Hendrickson, Transportation Investment and Pricing
Principles, John Wiley, New York, 1984.

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6.15 Problems
1. The Salisbury Corporation is considering four mutually exclusive
alternatives for a major capital investment project. All alternatives have a
useful life of 10 years with no salvage value at the end. Straight line
depreciation will be used. The corporation pays federal and state tax at a rate
of 34%, and expects an after-tax MARR of 10%. Determine which
alternative should be selected, using the NPV method.

Before-tax uniform
Initial cost annual net benefits
Alternatives ($million) ($million)
1 $4.0 $1.5
2 3.5 1.1
3 3.0 1.0
4 3.7 1.3
2.

3. The operating cash flow for the acquisition and maintenance of a clamshell
for excavation is given by At in the table below. Three financing plans, each
charging a borrowing rate of 8% but having a different method of -
repayment, are represented by three different cash flows of . Find the net
present value for each of the three combined cash flows AA t for operating
and financing if the MARR is specified to be 8%.

223
 Year Operating Financing
t (a) (b) (c)
0 -$80,000 $40,000 $40,000 $40,000
1 30,000 -10,020 -3,200 -13,200
2 30,000 -10,020 -3,200 -12,400
3 30,000 -10,020 -3,200 -11,600
4 30,000 -10,020 -3,200 -10,800
5 30,000 -10,020 -43,200 0
4.

5. Find the net present value for each of the three cases in Problem 2 if the
MARR is specified to be
(a) 5%
(b) 10%.

6. Suppose the clamshell in Problem 2 is purchased by a private firm which

pays corporate taxes at a rate of 34%. Depreciation is based on the straight
line method with no salvage value at the end of five years. If the after-tax
MARR of the firm is 8%, find the net present value for each of the combined
cash flows for operating and financing, including the interest deduction. The
interest payments included in the annual repayments of each of the loans are
8% times the unpaid principal in each year, with the following values:

Year (t) (a) (b) (c)

1 $800 $3,200 $3,200
2 664 3,200 2,400
3 516 3,200 1,600
4 357 3,200 800
5 185 3,200 0
7.

8. An investment in a hauler will cost $40,000 and have no salvage value at the
end of 5 years. The hauler will generate a gross income of $12,000 per year,
but its operating cost will be $2,000 during the first year, increasing by $500
per year until it reaches $5,000 in the fifth year. The straight line
depreciation method is used. The tax rate is 34% and the after-tax MARR is
10%. Determine the net present value of the hauler purchase for a five year
planning horizon.

9. The Bailey Construction Company is considering the purchase of a diesel

power shovel to improve its productivity. The shovel, which costs $80,000,
is expected to produce a before-tax benefit of $36,000 in the first year, and
$4,000 less in each succeeding year for a total of five years (i.e., before tax
benefit of $32,000 in the second year, $28,000 in the third year, continuing
to $20,000 in the fifth year). The salvage value of the equipment will be

224
 $5,000 at the end of 5 years. The firm uses the sum-of-years'-digits
depreciation for the equipment and has an annual tax rate of 34%. If the
MARR after tax is 10%, is the purchase worthwhile?

10. The ABC Corporation is considering the purchase of a number of pipe-

laying machines in order to facilitate the operation in a new pipeline project
expected to last six years. Each machine will cost $26,000 and will have no
salvage value after the project is complete. The firm uses the straight line
depreciation method and pays annual income taxes on profits at the rate of
34%. If the firm's MARR is 8%, which is the minimum uniform annual
benefit before tax that must be generated by this machine in order to justify
its purchase?

11. The Springdale Corporation plans to purchase a demolition and wrecking

machine to save labor costs. The machine costs $60,000 and has a salvage
value of $10,000 at the end of 5 years. The machine is expected to be in
operation for 5 years, and it will be depreciated by the straight line method
up to the salvage value. The corporation specifies an after-tax MARR
including inflation of 10% and has an income tax rate of 34%. The annual
inflation rate is expected to be 5% during the next 5 years. If the uniform
annual net benefit before tax in terms of base-year dollars for the next 5
years is $20,000, is the new investment worthwhile?

12. XYZ Company plans to invest $2 million in a new plant which is expected
to produce a uniform annual net benefit before tax of $600,000 in terms of
the base-year dollars over the next 6 years. The plant has a salvage value of
$250,000 at the end of 6 years and the depreciation allowance is based on the
straight line depreciation method. The corporate tax rate is 34%, and the
after-tax MARR specified by the firm is 10% excluding inflation. If the
annual inflation rate during the next 6 years is expected to be 5%, determine
whether the investment is worthwhile.

13. A sewage treatment plant is being planned by a public authority. Two

proposed designs require initial and annual maintenance costs as shown
below.

Year Design No. 1 Design No. 2

t ($1000s) ($1000s)
0 1,000 900
1-16(each) 150 180
14. Both designs will last 16 years with no salvage value. The federal
government will subsidize 50% of the initial capital cost, and the state
government has a policy to subsidize 10% of the annual maintenance cost.
The local community intends to obtain a loan to finance 30% of the initial
capital cost at a borrowing rate of 10% with sixteen equal annual payments

225
including principal and interest. The MARR for this type of project is 12%
reflecting its operating risk. What is the uniform annual revenue that must be
collected in the next 16 years to make each of the two designs worthwhile
from the view of the local authority? Which design has lower cost from this
perspective?

226
7. Financing of Constructed Facilities
7.1 The Financing Problem
Investment in a constructed facility represents a cost in the short term that returns
benefits only over the long term use of the facility. Thus, costs occur earlier than
the benefits, and owners of facilities must obtain the capital resources to finance the
costs of construction. A project cannot proceed without adequate financing, and the
cost of providing adequate financing can be quite large. For these reasons, attention
to project finance is an important aspect of project management. Finance is also a
concern to the other organizations involved in a project such as the general
contractor and material suppliers. Unless an owner immediately and completely
covers the costs incurred by each participant, these organizations face financing
problems of their own.

At a more general level, project finance is only one aspect of the general problem
of corporate finance. If numerous projects are considered and financed together,
then the net cash flow requirements constitutes the corporate financing problem for
capital investment. Whether project finance is performed at the project or at the
corporate level does not alter the basic financing problem.

In essence, the project finance problem is to obtain funds to bridge the time
between making expenditures and obtaining revenues. Based on the conceptual
plan, the cost estimate and the construction plan, the cash flow of costs and receipts
for a project can be estimated. Normally, this cash flow will involve expenditures
in early periods. Covering this negative cash balance in the most beneficial or cost
effective fashion is the project finance problem. During planning and design,
expenditures of the owner are modest, whereas substantial costs are incurred during
construction. Only after the facility is complete do revenues begin. In contrast, a
contractor would receive periodic payments from the owner as construction
proceeds. However, a contractor also may have a negative cash balance due to
delays in payment and retainage of profits or cost reimbursements on the part of
the owner.

Plans considered by owners for facility financing typically have both long and short
term aspects. In the long term, sources of revenue include sales, grants, and tax
revenues. Borrowed funds must be eventually paid back from these other sources.
In the short term, a wider variety of financing options exist, including borrowing,
grants, corporate investment funds, payment delays and others. Many of these
financing options involve the participation of third parties such as banks or bond
underwriters. For private facilities such as office buildings, it is customary to have
completely different financing arrangements during the construction period and
during the period of facility use. During the latter period, mortgage or loan funds

227
can be secured by the value of the facility itself. Thus, different arrangements of
financing options and participants are possible at different stages of a project, so the
practice of financial planning is often complicated.

On the other hand, the options for borrowing by contractors to bridge their
expenditures and receipts during construction are relatively limited. For small or
medium size projects, overdrafts from bank accounts are the most common form of
construction financing. Usually, a maximum limit is imposed on an overdraft
account by the bank on the basis of expected expenditures and receipts for the
duration of construction. Contractors who are engaged in large projects often own
substantial assets and can make use of other forms of financing which have lower
interest charges than overdrafting.

In recent years, there has been growing interest in design-build-operate projects in

which owners prescribe functional requirements and a contractor handles financing.
Contractors are repaid over a period of time from project revenues or government
payments. Eventually, ownership of the facilities is transferred to a government
entity. An example of this type of project is the Confederation Bridge to Prince
Edward Island in Canada.

In this chapter, we will first consider facility financing from the owner's
perspective, with due consideration for its interaction with other organizations
involved in a project. Later, we discuss the problems of construction financing
which are crucial to the profitability and solvency of construction contractors.

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7.2 Institutional Arrangements for Facility Financing

Financing arrangements differ sharply by type of owner and by the type of facility
construction. As one example, many municipal projects are financed in the United
States with tax exempt bonds for which interest payments to a lender are exempt
from income taxes. As a result, tax exempt municipal bonds are available at lower
interest charges. Different institutional arrangements have evolved for specific
types of facilities and organizations.

A private corporation which plans to undertake large capital projects may use its
retained earnings, seek equity partners in the project, issue bonds, offer new stocks
in the financial markets, or seek borrowed funds in another fashion. Potential
sources of funds would include pension funds, insurance companies, investment
trusts, commercial banks and others. Developers who invest in real estate properties
for rental purposes have similar sources, plus quasi-governmental corporations such
as urban development authorities. Syndicators for investment such as real estate
investment trusts (REITs) as well as domestic and foreign pension funds represent
relatively new entries to the financial market for building mortgage money.

228
Public projects may be funded by tax receipts, general revenue bonds, or special
bonds with income dedicated to the specified facilities. General revenue bonds
would be repaid from general taxes or other revenue sources, while special bonds
would be redeemed either by special taxes or user fees collected for the project.
Grants from higher levels of government are also an important source of funds for
state, county, city or other local agencies.

Despite the different sources of borrowed funds, there is a rough equivalence in the
actual cost of borrowing money for particular types of projects. Because lenders
can participate in many different financial markets, they tend to switch towards
loans that return the highest yield for a particular level of risk. As a result,
borrowed funds that can be obtained from different sources tend to have very
similar costs, including interest charges and issuing costs.

As a general principle, however, the costs of funds for construction will vary
inversely with the risk of a loan. Lenders usually require security for a loan
represented by a tangible asset. If for some reason the borrower cannot repay a
loan, then the borrower can take possession of the loan security. To the extent that
an asset used as security is of uncertain value, then the lender will demand a greater
return and higher interest payments. Loans made for projects under construction
represent considerable risk to a financial institution. If a lender acquires an
unfinished facility, then it faces the difficult task of re-assembling the project team.
Moreover, a default on a facility may result if a problem occurs such as foundation
problems or anticipated unprofitability of the future facility. As a result of these
uncertainties, construction lending for unfinished facilities commands a premium
interest charge of several percent compared to mortgage lending for completed
facilities.

Financing plans will typically include a reserve amount to cover unforeseen

expenses, cost increases or cash flow problems. This reserve can be represented by
a special reserve or a contingency amount in the project budget. In the simplest
case, this reserve might represent a borrowing agreement with a financial institution
to establish a line of credit in case of need. For publicly traded bonds, specific
reserve funds administered by a third party may be established. The cost of these
reserve funds is the difference between the interest paid to bondholders and the
interest received on the reserve funds plus any administrative costs.

Finally, arranging financing may involve a lengthy period of negotiation and

review. Particularly for publicly traded bond financing, specific legal requirements
in the issue must be met. A typical seven month schedule to issue revenue bonds
would include the various steps outlined in Table 7-1. [1] In many cases, the speed
in which funds may be obtained will determine a project's financing mechanism.

TABLE 7-1 Illustrative Process and Timing for Issuing Revenue Bonds
Activities Time of Activities

229
 Analysis of financial alternatives Weeks 0-4
Preparation of legal documents Weeks 1-17
Preparation of disclosure documents Weeks 2-20
Forecasts of costs and revenues Weeks 4-20
Bond Ratings Weeks 20-23
Bond Marketing Weeks 21-24
Bond Closing and Receipt of Funds Weeks 23-26

Example 7-1: Example of financing options

Suppose that you represent a private corporation attempting to arrange financing

for a new headquarters building. These are several options that might be
considered:

• Use corporate equity and retained earnings: The building could be

financed by directly committing corporate resources. In this case, no other
institutional parties would be involved in the finance. However, these
corporate funds might be too limited to support the full cost of construction.
• Construction loan and long term mortgage: In this plan, a loan is obtained
from a bank or other financial institution to finance the cost of construction.
Once the building is complete, a variety of institutions may be approached to
supply mortgage or long term funding for the building. This financing plan
would involve both short and long term borrowing, and the two periods
might involve different lenders. The long term funding would have greater
security since the building would then be complete. As a result, more
organizations might be interested in providing funds (including pension
funds) and the interest charge might be lower. Also, this basic financing plan
might be supplemented by other sources such as corporate retained earnings
or assistance from a local development agency.
• Lease the building from a third party: In this option, the corporation
would contract to lease space in a headquarters building from a developer.
This developer would be responsible for obtaining funding and arranging
construction. This plan has the advantage of minimizing the amount of funds
borrowed by the corporation. Under terms of the lease contract, the
corporation still might have considerable influence over the design of the
headquarters building even though the developer was responsible for design
and construction.
• Initiate a Joint Venture with Local Government: In many areas, local
governments will help local companies with major new ventures such as a
new headquarters. This help might include assistance in assembling
property, low interest loans or proerty tax reductions. In the extreme, local
governments may force sale of land through their power of eminent
domain to assemble necessary plots.

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230
7.3 Evaluation of Alternative Financing Plans
Since there are numerous different sources and arrangements for obtaining the
funds necessary for facility construction, owners and other project participants
require some mechanism for evaluating the different potential sources. The relative
costs of different financing plans are certainly important in this regard. In addition,
the flexibility of the plan and availability of reserves may be critical. As a project
manager, it is important to assure adequate financing to complete a project.
Alternative financing plans can be evaluated using the same techniques that are
employed for the evaluation of investment alternatives.

As described in Chapter 6, the availability of different financing plans can affect

the selection of alternative projects. A general approach for obtaining the combined
effects of operating and financing cash flows of a project is to determine the
adjusted net present value (APV) which is the sum of the net present value of the
operating cash flow (NPV) and the net present value of the financial cash flow
(FPV), discounted at their respective minimum attractive rates of return (MARR),
i.e.,

(7.1)

where r is the MARR reflecting the risk of the operating cash flow and rf is the
MARR representing the cost of borrowing for the financial cash flow. Thus,

(7.2)

where At and are respectively the operating and financial cash flows in period t.

For the sake of simplicity, we shall emphasize in this chapter the evaluation of
financing plans, with occasional references to the combined effects of operating
and financing cash flows. In all discussions, we shall present various financing
schemes with examples limiting to cases of before-tax cash flows discounted at a
before-tax MARR of r = rf for both operating and financial cash flows. Once the
basic concepts of various financing schemes are clearly understood, their
application to more complicated situations involving depreciation, tax liability and
risk factors can be considered in combination with the principles for dealing with
such topics enunciated in Chapter 6.

In this section, we shall concentrate on the computational techniques associated

with the most common types of financing arrangements. More detailed descriptions

231
of various financing schemes and the comparisons of their advantages and
disadvantages will be discussed in later sections.

Typically, the interest rate for borrowing is stated in terms of annual percentage
rate (A.P.R.), but the interest is accrued according to the rate for the interest period
specified in the borrowing agreement. Let ip be the nominal annual percentage rate,
and i be the interest rate for each of the p interest periods per year. By definition

(7.3)

If interest is accrued semi-annually, i.e., p = 2, the interest rate per period is i p/2;
similarly if the interest is accrued monthly, i.e., p = 12, the interest rate per period
is ip/12. On the other hand, the effective annual interest rate ie is given by:

(7.4)

Note that the effective annual interest rate, ie, takes into account compounding
within the year. As a result, ie is greater than ip for the typical case of more than one
compounding period per year.

For a coupon bond, the face value of the bond denotes the amount borrowed
(called principal) which must be repaid in full at a maturity or due date, while each
coupon designates the interest to be paid periodically for the total number of
coupons covering all periods until maturity. Let Q be the amount borrowed, and
Ip be the interest payment per period which is often six months for coupon bonds. If
the coupon bond is prescribed to reach maturity in n years from the date of issue,
the total number of interest periods will be pn = 2n. The semi-annual interest
payment is given by:

(7.5)

In purchasing a coupon bond, a discount from or a premium above the face value
may be paid.

An alternative loan arrangement is to make a series of uniform payments including

both interest and part of the principal for a pre-defined number of repayment
periods. In the case of uniform payments at an interest rate i for n repayment
periods, the uniform repayment amount U is given by:

232
(7.6)

where (U|P,i,n) is a capital recovery factor which reads: "to find U, given P=1, for
an interest rate i over n periods." Compound interest factors are as tabulated in
Appendix A. The number of repayment periods n will clearly influence the
amounts of payments in this uniform payment case. Uniform payment bonds or
mortgages are based on this form of repayment.

Usually, there is an origination fee associated with borrowing for legal and other
professional services which is payable upon the receipt of the loan. This fee may
appear in the form of issuance charges for revenue bonds or percentage point
charges for mortgages. The borrower must allow for such fees in addition to the
construction cost in determining the required original amount of borrowing.
Suppose that a sum of Po must be reserved at t=0 for the construction cost, and K is
the origination fee. Then the original loan needed to cover both is:

(7.7)

If the origination fee is expressed as k percent of the original loan, i.e., K = kQ 0,

then:

(7.8)

Since interest and sometimes parts of the principal must be repaid periodically in
most financing arrangements, an amount Q considerably larger than Q0 is usually
borrowed in the beginning to provide adequate reserve funds to cover interest
payments, construction cost increases and other unanticipated shortfalls. The net
amount received from borrowing is deposited in a separate interest bearing account
from which funds will be withdrawn periodically for necessary payments. Let the
borrowing rate per period be denoted by i and the interest for the running balance
accrued to the project reserve account be denoted by h. Let At be the net operating
cash flow for - period t (negative for construction cost in period t) and be the
net financial cash flow in period t (negative for payment of interest or principal or a
combination of both). Then, the running balance Nt of the project reserve account
can be determined by noting that at t=0,

(7.9)

and at t = 1,2,...,n:

233
(7.10)

where the value of At or t may be zero for some period(s). Equations (7.9) and
(7.10) are approximate in that interest might be earned on intermediate balances
based on the pattern of payments during a period instead of at the end of a period.

Because the borrowing rate i will generally exceed the investment rate h for the
running balance in the project account and since the origination fee increases with
the amount borrowed, the financial planner should minimize the amount of money
borrowed under this finance strategy. Thus, there is an optimal value for Q such
that all estimated shortfalls are covered, interest payments and expenses are
minimized, and adequate reserve funds are available to cover unanticipated factors
such as construction cost increases. This optimal value of Q can either be identified
analytically or by trial and error.

Finally, variations in ownership arrangements may also be used to provide at least

partial financing. Leasing a facility removes the need for direct financing of the
facility. Sale-leaseback involves sale of a facility to a third party with a separate
agreement involving use of the facility for a pre-specified period of time. In one
sense, leasing arrangements can be viewed as a particular form of financing. In
return for obtaining the use of a facility or piece of equipment, the user (lesser)
agrees to pay the owner (lesser) a lease payment every period for a specified
number of periods. Usually, the lease payment is at a fixed level due every month,
semi-annually, or annually. Thus, the cash flow associated with the equipment or
facility use is a series of uniform payments. This cash flow would be identical to a
cash flow resulting from financing the facility or purchase with sufficient borrowed
funds to cover initial construction (or purchase) and with a repayment schedule of
uniform amounts. Of course, at the end of the lease period, the ownership of the
facility or equipment would reside with the lesser. However, the lease terms may
include a provision for transferring ownership to the lesser after a fixed period.

Example 7-2: A coupon bond cash flow and cost

A private corporation wishes to borrow $10.5 million for the construction of a new
building by issuing a twenty-year coupon bond at an annual percentage interest rate
of 10% to be paid semi-annually, i.e. 5% per interest period of six months. The
principal will be repaid at the end of 20 years. The amount borrowed will cover the
construction cost of $10.331 million and an origination fee of $169,000 for issuing
the coupon bond.

The interest payment per period is (5%) (10.5) = $0.525 million over a life time of
(2) (20) = 40 interest periods. Thus, the cash flow of financing by the coupon bond

234
consists of a $10.5 million receipt at period 0, -$0.525 million each for periods 1
through 40, and an additional -$10.5 million for period 40. Assuming a MARR of
5% per period, the net present value of the financial cash flow is given by:

[FPV]5%) = 10.5 - (0.525)(P|U, 5%, 40) - (10.5)(P|F, 5%, 40) = 0

This result is expected since the corporation will be indifferent between borrowing
and diverting capital from other uses when the MARR is identical to the borrowing
rate. Note that the effective annual rate of the bond may be computed according to
Eq.(7.4) as follows:

ie = (1 + 0.05)2 - 1 = 0.1025 = 10.25%

If the interest payments were made only at the end of each year over twenty years,
the annual payment should be:

0.525(1 + 0.05) + 0.525 = 1.076

where the first term indicates the deferred payment at the mid-year which would
accrue interest at 5% until the end of the year, then:

[FPV]10.25% = 10.5 - (1.076)(P|U, 10.25%, 20) - (10.5)(P|F, 10.25%, 20) = 0

In other words, if the interest is paid at 10.25% annually over twenty years of the
loan, the result is equivalent to the case of semi-annual interest payments at 5%
over the same lifetime.

Example 7-3: An example of leasing versus ownership analysis

Suppose that a developer offered a building to a corporation for an annual lease

payment of $10 million over a thirty year lifetime. For the sake of simplicity, let us
assume that the developer also offers to donate the building to the corporation at
the end of thirty years or, alternatively, the building would then have no
commercial value. Also, suppose that the initial cost of the building was $65.66
million. For the corporation, the lease is equivalent to receiving a loan with uniform
payments over thirty years at an interest rate of 15% since the present value of the
lease payments is equal to the initial cost at this interest rate:

If the minimum attractive rate of return of the corporation is greater than 15%, then
this lease arrangement is advantageous as a financing scheme since the net present

235
value of the leasing cash flow would be less than the cash flow associated with
construction from retained earnings. For example, with MARR equal to 20%:

[FPV]20% = $65.66 million - ($10 million)(P|U, 20%, 30) = $15.871 million

On the other hand, with MARR equal to 10%:

[FPV]10% = $65.66 million - ($10 million)(P|U, 20%, 30) = $28.609 million

and the lease arrangement is not advantageous.

Example 7-4: Example evaluation of alternative financing plans.

Suppose that a small corporation wishes to build a headquarters building. The

construction will require two years and cost a total of $12 million, assuming that $5
million is spent at the end of the first year and $7 million at the end of the second
year. To finance this construction, several options are possible, including:

• Investment from retained corporate earnings;

• Borrowing from a local bank at an interest rate of 11.2% with uniform
annual payments over twenty years to pay for the construction costs. The
shortfalls for repayments on loans will come from corporate earnings. An
origination fee of 0.75% of the original loan is required to cover engineer's
reports, legal issues, etc; or
• A twenty year coupon bond at an annual interest rate of 10.25% with interest
payments annually, repayment of the principal in year 20, and a $169,000
origination fee to pay for the construction cost only.

The current corporate MARR is 15%, and short term cash funds can be deposited in
an account having a 10% annual interest rate.

The first step in evaluation is to calculate the required amounts and cash flows
associated with these three alternative financing plans. First, investment using
retained earnings will require a commitment of $5 million in year 1 and $7 million
in year 2.

Second, borrowing from the local bank must yield sufficient funds to cover both
years of construction plus the issuing fee. With the unused fund accumulating
interest at a rate of 10%, the amount of dollars needed at the beginning of the first
year for future construction cost payments is:

P0 = ($5 million)/(1.1) + ($7 million)/(1.1)2 = $10.331 million

Discounting at ten percent in this calculation reflects the interest earned in the
intermediate periods. With a 10% annual interest rate, the accrued interests for the
first two years from the project account of $10.331 at t=0 will be:

236
Year 1: I1 = (10%)(10.331 million) = $1.033 million
Year 2: I2 = (10%)(10.331 million + $1.033 million - $5.0 million) = 0.636 million

Since the issuance charge is 0.75% of the loan, the amount borrowed from the bank
at t=0 to cover both the construction cost and the issuance charge is

Q0 = ($10.331 million)/(1 - 0.0075) = $ 10.409 million

The issuance charge is 10.409 - 10.331 = $ 0.078 million or $78,000. If this loan is
to be repaid by annual uniform payments from corporate earnings, the amount of
each payment over the twenty year life time of the loan can be calculated by Eq.
(7.6) as follows:

U = ($10.409 million)[(0.112)(1.112)20]/[(1.112)20 - 1] = $1.324 million

Finally, the twenty-year coupon bond would have to be issued in the amount of
$10.5 million which will reflect a higher origination fee of $169,000. Thus, the
amount for financing is:

Q0 = $10.331 million + $0.169 million = $10.5 million

With an annual interest charge of 10.25% over a twenty year life time, the annual
payment would be $1.076 million except in year 20 when the sum of principal and
interest would be 10.5 + 1.076 = $11.576 million. The computation for this case of
borrowing has been given in Example 7-2.

Table 7-2 summarizes the cash flows associated with the three alternative financing
plans. Note that annual incomes generated from the use of this building have not
been included in the computation. The adjusted net present value of the combined
operating and financial cash flows for each of the three plans discounted at the
corporate MARR of 15% is also shown in the table. In this case, the coupon bond is
the least expensive financing plan. Since the borrowing rates for both the bank loan
and the coupon bond are lower than the corporate MARR, these results are
expected.

TABLE 7-2 Cash Flow Illustration of Three Alternative Financing Plans (in $ millions)
Year Source Retained Earnings Bank Loan Coupon Bond
0 Principal - $10.409 $10.500
0 Issuing Cost - - 0.078 - 0.169
1 Earned Interest - 1.033 1.033
1 Contractor Payment - 5.000 - 5.000 - 5.000
1 Loan Repayment - - 1.324 - 1.076
2 Earned Interest - 0.636 0.636
2 Contractor Payment - 7.000 - 7.000 - 7.000
2 Loan Repayment - - 1.324 - 1.076
3-19 Loan Repayment - - 1.324 -1.076

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 20 Loan Repayment - - 1.324 - 11.576

[APV]15% - 9.641 - 6.217 - 5.308

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7.4 Secured Loans with Bonds, Notes and Mortgages

Secured lending involves a contract between a borrower and lender, where the
lender can be an individual, a financial institution or a trust organization. Notes and
mortgages represent formal contracts between financial institutions and owners.
Usually, repayment amounts and timing are specified in the loan agreement. Public
facilities are often financed by bond issues for either specific projects or for groups
of projects. For publicly issued bonds, a trust company is usually designated to
represent the diverse bond holders in case of any problems in the repayment. The
borrowed funds are usually secured by granting the lender some rights to the
facility or other assets in case of defaults on required payments. In contrast,
corporate bonds such as debentures can represent loans secured only by the good
faith and credit worthiness of the borrower.

Under the terms of many bond agreements, the borrower reserves the right to
repurchase the bonds at any time before the maturity date by repaying the principal
and all interest up to the time of purchase. The required repayment R c at the end of
period c is the net future value of the borrowed amount Q - less the payment
made at intermediate periods compounded at the borrowing rate i to period c as
follows:

(7.11)

The required repayment Rc at the end of the period c can also be obtained by noting
the net present value of the repayments in the remaining (n-c) periods discounted at
the borrowing rate i to t = c as follows:

(7.12)

For coupon bonds, the required repayment Rc after the redemption of the coupon at
the end of period c is simply the original borrowed amount Q. For uniform payment
bonds, the required repayment Rc after the last payment at the end of period c is:

238
(7.13)

Many types of bonds can be traded in a secondary market by the bond holder. As
interest rates fluctuate over time, bonds will gain or lose in value. The actual value
of a bond is reflected in the market discount or premium paid relative to the
original principal amount (the face value). Another indicator of this value is
the yield to maturity or internal rate of return of the bond. This yield is calculated
by finding the interest rate that sets the (discounted) future cash flow of the bond
equal to the current market price:

(7.14)

where Vc is the current market value after c periods have lapsed since the - issuance
of the bond, is the bond cash flow in period t, and r is the market yield. Since
all the bond cash flows are positive after the initial issuance, only one value of the
yield to maturity will result from Eq. (7.14).

Several other factors come into play in evaluation of bond values from the lenders
point of view, however. First, the lender must adjust for the possibility that the
borrower may default on required interest and principal payments. In the case of
publicly traded bonds, special rating companies divide bonds into different
categories of risk for just this purpose. Obviously, bonds that are more likely to
default will have a lower value. Secondly, lenders will typically make adjustments
to account for changes in the tax code affecting their after-tax return from a bond.
Finally, expectations of future inflation or deflation as well as exchange rates will
influence market values.

Another common feature in borrowing agreements is to have a variable interest

rate. In this case, interest payments would vary with the overall market interest rate
in some pre-specified fashion. From the borrower's perspective, this is less
desirable since cash flows are less predictable. However, variable rate loans are
typically available at lower interest rates because the lenders are protected in some
measure from large increases in the market interest rate and the consequent
decrease in value of their expected repayments. Variable rate loans can have floors
and ceilings on the applicable interest rate or on rate changes in each year.

Example 7-5: Example of a corporate promissory note

239
A corporation wishes to consider the option of financing the headquarters building
in Example 7-4 by issuing a five year promissory note which requires an
origination fee for the note is $25,000. Then a total borrowed amount needed at the
beginning of the first year to pay for the construction costs and origination fee is
10.331 + 0.025 = $10.356 million. Interest payments are made annually at an
annual rate of 10.8% with repayment of the principal at the end of the fifth year.
Thus, the annual interest payment is (10.8%)(10.356) = $1.118 million. With the
data in Example 7-4 for construction costs and accrued interests for the first two
year, the combined operating and and financial cash flows in million dollars can be
obtained:
Year 0, AA0 = 10.356 - 0.025 = 10.331
Year 1, AA1 = 1.033 - 5.0 - 1.118 = -5.085
Year 2, AA2 = 0.636 - 7.0 - 1.118 = -7.482
Year 3, AA3 = -1.118
Year 4, AA4 = -1.118
Year 5, AA5 = -1.118 - 10.356 = -11.474
At the current corporate MARR of 15%,

which is inferior to the 20-year coupon bond analyzed in Table 7-3.

For this problem as well as for the financing arrangements in Example 7-4, the
project account is maintained to pay the construction costs only, while the interest
and principal payments are repaid from corporate earnings. - Consequently, the
terms in Eq. (7.10) will disappear when the account balance in each period is
computed for this problem:

At t=0, N0 = 10.356 - 0.025 = $10.331 million

At t=1, N1 = (1 + 0.1) (10.331) - 5.0 = $6.364 million
At t=2, N2 = (1 + 0.1) (6.364) - 7.0 = $0

Example 7-6: Bond financing mechanisms.

Suppose that the net operating expenditures and receipts of a facility investment
over a five year time horizon are as shown in column 2 of Table 7-3 in which each
period is six months. This is a hypothetical example with a deliberately short life
time period to reduce the required number of calculations. Consider two alternative
bond financing mechanisms for this project. Both involve borrowing $2.5 million at
an issuing cost of five percent of the loan with semi-annual repayments at a
nominal annual interest rate of ten percent i.e., 5% per period. Any excess funds
can earn an interest of four percent each semi-annual period. The coupon bond
involves only interest payments in intermediate periods, plus the repayment of the

240
principal at the end, whereas the uniform payment bond requires ten uniform
payments to cover both interests and the principal. Both bonds are subject to
optional redemption by the borrower before maturity.

The operating cash flow in column 2 of Table 7-3 represents the construction
expenditures in the early periods and rental receipts in later periods over the
lifetime of the facility. By trial and error with Eqs. (7.9) and (7.10), it can be found
that Q = $2.5 million (K = $0.125 or 5% of Q) is necessary to insure a nonnegative
balance in the project account for the uniform payment bond, as shown in Column
6 of Table 7-3. For the purpose of comparison, the same amount is borrowed for
the coupon bond option even though a smaller loan will be sufficient for the
construction expenditures in this case.

The financial cash flow of the coupon bond can easily be derived from Q = $2.5
million and K = $0.125 million. Using Eq. (7.5), Ip = (5%)(2.5) = $0.125 million,
and the repayment in Period 10 is Q + Ip = $2.625 million as shown in Column 3 of
Table 7-3. The account balance for the coupon bond in Column 4 is obtained from
Eqs. (7.9) and (7.10). On the other hand, the uniform annual payment U = $0.324
million for the financial cash flow of the uniform payment bond (Column 5) can be
obtained from Eq. (7.6), and the bond account for this type of balance is computed
by Eqs. (7.9) and (7.10).

Because of the optional redemption provision for both types of bonds, it is

advantageous to gradually redeem both options at the end of period 3 to avoid
interest payments resulting from i = 5% and h = 4% unless the account balance
beyond period 3 is needed to fund other corporate investments. corporate earnings
are available for repurchasing the bonds at end of period 3, the required repayment
for coupon bond after redeeming the last coupon at the end of period 3 is simply
$2.625 million. In the case of the uniform payment bond, the required payment
after the last uniform payment at the end of period 3 is obtained from Equation (7-
13) as:

R3 = (0.324)(P|U, 5%, 7) = (0.324)(5.7864) = $1.875 million.

TABLE 7-3 Example of Two Borrowing Cash Flows (in $ thousands)
Operating Cash Coupon Cash Account Uniform Cash Account
Period Flow Flow Balance Flow Balance
0 - $2,375 $2,375 $2,375 $2,375
1 - $800 - 125 1,545 - 324 1,346
2 -700 - 125 782 - 324 376
3 -60 - 125 628 - 324 8
4 400 - 125 928 - 324 84
5 600 - 125 1,440 - 324 364
6 800 - 125 2,173 - 324 854
7 1,000 - 125 3,135 - 324 1,565
8 1,000 - 125 4,135 - 324 2,304
9 1,000 - 125 5,176 - 324 3,072

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10 1,000 - 2,625 3,758 - 324 3,871

Example 7-7: Provision of Reserve Funds

Typical borrowing agreements may include various required reserve

funds. [2] Consider an eighteen month project costing five million dollars. To
finance this facility, coupon bonds will be issued to generate revenues which must
be sufficient to pay interest charges during the eighteen months of construction, to
cover all construction costs, to pay issuance expenses, and to maintain a debt
service reserve fund. The reserve fund is introduced to assure bondholders of
payments in case of unanticipated construction problems. It is estimated that a total
amount of $7.4 million of bond proceeds is required, including a two percent
discount to underwriters and an issuance expense of $100,000.

Three interest bearing accounts are established with the bond proceeds to separate
various categories of funds:

• A construction fund to provide payments to contractors, with an initial

balance of $4,721,600. Including interest earnings, this fund will be
sufficient to cover the $5,000,000 in construction expenses.
• A capitalized interest fund to provide interest payments during the
construction period. /li>
• A debt service reserve fund to be used for retiring outstanding debts after the
completion of construction.

The total sources of funds (including interest from account balances) and uses of
funds are summarized in Table 7-4

TABLE 7-4 Illustrative Sources and Uses of Funds from Revenue Bonds During Construction
Sources of Funds
Bond Proceeds $7,400,000
Interest Earnings on Construction Fund 278,400
Interest Earnings of Capitalized Interest Fund 77,600
Interest Earnings on Debt Service Reserve Fund 287,640
Total Sources of Funds $8,043,640
Uses of Funds
Construction Costs $5,000,000
Interest Payments 904,100
Debt Service Reserve Fund 1,891,540
Bond Discount (2.0%) 148,000
Issuance Expense 100,000
Total Uses of Funds $8,043,640

Example 7-8: Variable rate revenue bonds prospectus

242
The information in Table 7-5 is abstracted from the Prospectus for a new issue of
revenue bonds for the Atwood City. This prospectus language is typical for
municipal bonds. Notice the provision for variable rate after the initial interest
periods. The borrower reserves the right to repurchase the bond before the date for
conversion to variable rate takes effect in order to protect itself from declining
market interest rates in the future so that the borrower can obtain other financing
arrangements at lower rates.
TABLE 7-5 Provision of Variable Rate for Bonds
First series of 1987: $12,000,000
Date: December 1, 1987 Due: November 1, 2017
The Bonds will be issued as fully registered bonds in the denomination of
$5,000 or any multiple thereof. Principal or redemption price of the bonds
will be payable upon surrender thereof. Interest on the Bonds will be
payable on May 1, 1988, and semi-annually thereafter on November 1 and
May 1 by check mailed to the Bondowners registered on the State
Authority's books on the Record Date. The proceeds of the Bonds will be
loaned to Atwood City under a loan agreement, dated as of November 1,
1987 between the State Authority and Gerald Bank as Trustee and Paying
Agent. The Bonds will bear interest at a semi-annual fixed rate of 4% for
the initial interest periods from December 1, 1987 through April 1, 1990,
after which the Bonds may be converted to semi-annual variable mode at
the option of Atwood City upon proper notice. If the bonds are so
converted, such Bonds must be tendered for mandatory purchase at par, plus
1/8th of 1% of principal amount under certain circumstances and accrued
interest to the Purchase Date (unless the Bondowner files a Non-tender
Election). To be so purchased, Bonds must be delivered, accompanied by a
notice of election to tender the Bonds, to the Paying Agent between the
opening of business on the first day of the month preceding the effective
rate date of the Bonds and 4:00 pm New York City time on the fifteenth day
preceding such effective rate date for the Bonds.

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7.5 Overdraft Accounts

Overdrafts can be arranged with a banking institution to allow accounts to have
either a positive or a negative balance. With a positive balance, interest is paid on
the account balance, whereas a negative balance incurs interest charges. Usually, an
overdraft account will have a maximum overdraft limit imposed. Also, the interest
rate h available on positive balances is less than the interest rate i charged for
borrowing.

Clearly, the effects of overdraft financing depends upon the pattern of cash flows
over time. Suppose that the net cash flow for period t in the account is denoted by
At which is the difference between the receipt Pt and the payment Et in period t.

243
Hence, At can either be positive or negative. The amount of overdraft at the end of
period t is the cumulative net cash flow N t which may also be positive or negative.
If Nt is positive, a surplus is indicated and the subsequent interest would be paid to
the borrower. Most often, Nt is negative during the early time periods of a project
and becomes positive in the later periods when the borrower has received payments
exceeding expenses.

If the borrower uses overdraft financing and pays the interest per period on the
accumulated overdraft at a borrowing rate i in each period, then the interest per
period for the accumulated overdraft Nt-1 from the previous period (t-1) is It = iNt-
1 where It would be negative for a negative account balance Nt-1. For a positive
account balance, the interest received is It = hNt-1 where It would be positive for a
positive account balance.

The account balance Nt at each period t is the sum of receipts Pt, payments Et,
interest It and the account balance from the previous period Nt-1. Thus,

(7.15)

where It = iNt-1 for a negative Nt-1 and It = hNt-1 for a positive Nt-1. The net cash flow
At = Pt - Et is positive for a net receipt and negative for a net payment. This
equation is approximate in that the interest might be earned on intermediate
balances based on the pattern of payments during the period instead of at the end of
a period. The account balance in each period is of interest because there will always
be a maximum limit on the amount of overdraft available.

For the purpose of separating project finances with other receipts and payments in
an organization, it is convenient to establish a credit account into which receipts
related to the project must be deposited when they are received, and all payments
related to the project will be withdrawn from this account when they are needed.
Since receipts typically lag behind payments for a project, this credit account will
have a negative balance until such time when the receipts plus accrued interests are
equal to or exceed payments in the period. When that happens, any surplus will not
be deposited in the credit account, and the account is then closed with a zero
balance. In that case, for negative Nt-1, Eq. (7.15) can be expressed as:

(7.16)

and as soon as Nt reaches a positive value or zero, the account is closed.

Example 7-9: Overdraft Financing with Grants to a Local Agency

244
A public project which costs $61,525,000 is funded eighty percent by a federal
grant and twenty percent from a state grant. The anticipated duration of the project
is six years with receipts from grant funds allocated at the end of each year to a
local agency to cover partial payments to contractors for that year while the
remaining payments to contractors will be allocated at the end of the sixth year.
The end-of-year payments are given in Table 7-6 in which t=0 refers to the
beginning of the project, and each period is one year.

If this project is financed with an overdraft at an annual interest rate i = 10%, then
the account balance are computed by Eq. (7.15) and the results are shown in Table
7-6.

In this project, the total grant funds to the local agency covered the cost of
construction in the sense that the sum of receipts equaled the sum of construction
payments of $61,525,000. However, the timing of receipts lagged payments, and
the agency incurred a substantial financing cost, equal in this plan to the overdraft
amount of $1,780,000 at the end of year 6 which must be paid to close the credit
account. Clearly, this financing problem would be a significant concern to the local
agency.

TABLE 7-6 Illustrative Payments, Receipts and

Overdrafts for a Six Year Project
Period t Receipts Pt Payments Et Interest It Account Nt
0 0 0 0 0
1 $5.826 $6.473 0 -$0.647
2 8.401 9.334 - $0.065 - 1.645
3 12.013 13.348 - 0.165 - 3.145
4 15.149 16.832 - 0.315 - 5.143
5 13.984 15.538 - 0.514 - 7.211
6 6.152 0 - 0.721 - 1.780
Total $61.525 $61.525 -$1.780

Example 7-10: Use of overdraft financing for a facility

A corporation is contemplating an investment in a facility with the following

before-tax operating net cash flow (in thousands of dollars) at year ends:
Year 0 1 2 3 4 5 6 7
Cash Flow -500 110 112 114 116 118 120 238

The MARR of the corporation before tax is 10%. The corporation will finance the
facility be using $200,000 from retained earnings and by borrowing the remaining
$300,000 through an overdraft credit account which charges 14% interest for
borrowing. Is this proposed project including financing costs worthwhile?

The results of the analysis of this project is shown in Table 7-7 as follows:

245
N0 = -500 + 200 = -300
N1 = (1.14)(-300) + 110 = -232
N2 = (1.14)(-232) + 112 = -152.48
N3 = (1.14)(-152.48) + 114 = -59.827
N4 = (1.14)(-59.827) +116 = +47.797

Since N4 is positive, it is revised to exclude the net receipt of 116 for this period.
Then, the revised value for the last balance is

N4' = N4 - 116 = - 68.203

The financial cash flow resulting from using overdrafts and making repayments
from project receipts will be:

= - N0 = 300
= - A1 = -110
= - A2 = -112
= - A3 = -114
= N4 - A4 = - 68.203

The adjusted net present value of the combined cash flow discounted at 15% is
$27,679 as shown in Table 7-7. Hence, the project including the financing charges
is worthwhile.

TABLE 7-7 Evaluation of Facility Financing Using Overdraft (in $

thousands)
End of Operating Cash Overdraft Financing Cash Combined Cash
Year Flow Balance Flow Flow
t At Nt AAt
0 - $500 &300 - $200
- $300
1 110 - 110 0
- 232
2 112 - 112 0
- 152.480
3 114 - 114 0
-59.827
4 116 - 68.203 47.797
0
5 118 0 118
0
6 120 0 120
0
7 122 0 122
0
[PV]15% $21.971 $5.708 $27.679

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246
7.6 Refinancing of Debts
Refinancing of debts has two major advantages for an owner. First, they allow re-
financing at intermediate stages to save interest charges. If a borrowing agreement
is made during a period of relatively high interest charges, then a repurchase
agreement allows the borrower to re-finance at a lower interest rate. Whenever the
borrowing interest rate declines such that the savings in interest payments will
cover any transaction expenses (for purchasing outstanding notes or bonds and
arranging new financing), then it is advantageous to do so.

Another reason to repurchase bonds is to permit changes in the operation of a

facility or new investments. Under the terms of many bond agreements, there may
be restrictions on the use of revenues from a particular facility while any bonds are
outstanding. These restrictions are inserted to insure bondholders that debts will be
repaid. By repurchasing bonds, these restrictions are removed. For example, several
bridge authorities had bonds that restricted any diversion of toll revenues to other
transportation services such as transit. By repurchasing these bonds, the authority
could undertake new operations. This type of repurchase may occur voluntarily
even without a repurchase agreement in the original bond. The borrower may give
bondholders a premium to retire bonds early.

Example 7-11: Refinancing a loan.

Suppose that the bank loan shown in Example 7-4 had a provision permitting the
borrower to repay the loan without penalty at any time. Further, suppose that
interest rates for new loans dropped to nine percent at the end of year six of the
loan. Issuing costs for a new loan would be $50,000. Would it be advantageous to
re-finance the loan at that time?

To repay the original loan at the end of year six would require a payment of the
remaining principal plus the interest due at the end of year six. This amount R6 is
equal to the present value of remaining fourteen payments discounted at the loan
interest rate 11.2% to the end of year 6 as given in Equation (7-13) as follows:

The new loan would be in the amount of $ 9.152 million plus the issuing cost of
$0.05 million for a total of $ 9.202 million. Based on the new loan interest rate of
9%, the new uniform annual payment on this loan from years 7 to 20 would be:

247
The net present value of the financial cash flow for the new loan would be obtained
by discounting at the corporate MARR of 15% to the end of year six as follows:

Since the annual payment on the new loan is less than the existing loan ($1.182
versus $1.324 million), the new loan is preferable.
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7.7 Project versus Corporate Finance

We have focused so far on problems and concerns at the project level. While this is
the appropriate viewpoint for project managers, it is always worth bearing in mind
that projects must fit into broader organizational decisions and structures. This is
particularly true for the problem of project finance, since it is often the case that
financing is planned on a corporate or agency level, rather than a project level.
Accordingly, project managers should be aware of the concerns at this level of
decision making.

A construction project is only a portion of the general capital budgeting problem

faced by an owner. Unless the project is very large in scope relative to the owner, a
particular construction project is only a small portion of the capital budgeting
problem. Numerous construction projects may be lumped together as a single
category in the allocation of investment funds. Construction projects would
compete for attention with equipment purchases or other investments in a private
corporation.

Financing is usually performed at the corporate level using a mixture of long term
corporate debt and retained earnings. A typical set of corporate debt instruments
would include the different bonds and notes discussed in this chapter. Variations
would typically include different maturity dates, different levels of security
interests, different currency denominations, and, of course, different interest rates.

Grouping projects together for financing influences the type of financing that might
be obtained. As noted earlier, small and large projects usually involve different
institutional arrangements and financing arrangements. For small projects, the fixed
costs of undertaking particular kinds of financing may be prohibitively expensive.
For example, municipal bonds require fixed costs associated with printing and
preparation that do not vary significantly with the size of the issue. By combining
numerous small construction projects, different financing arrangements become
more practical.

While individual projects may not be considered at the corporate finance level, the
problems and analysis procedures described earlier are directly relevant to financial

248
planning for groups of projects and other investments. Thus, the net present values
of different financing arrangements can be computed and compared. Since the net
present values of different sub-sets of either investments or financing alternatives
are additive, each project or finance alternative can be disaggregated for closer
attention or aggregated to provide information at a higher decision making level.

Example 7-12: Basic types of repayment schedules for loans.

Coupon bonds are used to obtain loans which involve no payment of principal until
the maturity date. By combining loans of different maturities, however, it is
possible to achieve almost any pattern of principal repayments. However, the
interest rates charged on loans of different maturities will reflect market forces such
as forecasts of how interest rates will vary over time. As an example, Table 7-8
illustrates the cash flows of debt service for a series of coupon bonds used to fund a
municipal construction project; for simplicity not all years of payments are shown
in the table.

In this financing plan, a series of coupon bonds were sold with maturity dates
ranging from June 1988 to June 2012. Coupon interest payments on all outstanding
bonds were to be paid every six months, on December 1 and June 1 of each year.
The interest rate or "coupon rate" was larger on bonds with longer maturities,
reflecting an assumption that inflation would increase during this period. The total
principal obtained for construction was $26,250,000 from sale of these bonds. This
amount represented the gross sale amount before subtracting issuing costs or any
sales discounts; the amount available to support construction would be lower. The
maturity dates for bonds were selected to require relative high repayment amounts
until December 1995, with a declining repayment amount subsequently. By shifting
the maturity dates and amounts of bonds, this pattern of repayments could be
altered. The initial interest payment (of $819,760 on December 1, 1987), reflected a
payment for only a portion of a six month period since the bonds were issued in
late June of 1987.

TABLE 7-8 Illustration of a Twenty-five Year Maturity Schedule for Bonds

Corresponding Interest
Date Maturing Principal Rate Interest Due Annual Debt Service
Dec. 1, 1987 $819,760 $819,760
June 1, 1988 $1,350,000 5.00% 894,429
Dec. 1, 1988 860,540 3,104,969
June 1, 1989 1,450,000 5.25 860,540
Dec. 1, 1989 822,480 3,133,020
June 1, 1990 1,550,000 5.50 822,480
Dec. 1, 1990 779,850 3,152,330
June 1, 1991 1,600,000 5.80 779,850
Dec. 1, 1991 733,450 3,113,300
June 1, 1992 1,700,000 6.00 733,450
Dec. 1, 1992 682,450 3,115,900

249
June 1, 1993 1,800,000 6.20 682,450
Dec. 1, 1993 626,650 3,109,100
. . . . .
. . . . .
. . . . .
June 1, 2011 880,000 8.00 68,000
Dec. 1, 2011 36,000 984,000
June 1, 2012 96,000 8.00 36,000
Dec. 1, 2012 996,000

Back to top

7.8 Shifting Financial Burdens

The different participants in the construction process have quite distinct
perspectives on financing. In the realm of project finance, the revenues to one
participant represent an expenditure to some other participant. Payment delays from
one participant result in a financial burden and a cash flow problem to other
participants. It is common occurrence in construction to reduce financing costs by
delaying payments in just this fashion. Shifting payment times does not eliminate
financing costs, however, since the financial burden still exists.

Traditionally, many organizations have used payment delays both to shift financing
expenses to others or to overcome momentary shortfalls in financial resources.
From the owner's perspective, this policy may have short term benefits, but it
certainly has long term costs. Since contractors do not have large capital assets,
they typically do not have large amounts of credit available to cover payment
delays. Contractors are also perceived as credit risks in many cases, so loans often
require a premium interest charge. Contractors faced with large financing problems
are likely to add premiums to bids or not bid at all on particular work. For example,
A. Maevis noted: [3]

...there were days in New York City when city agencies had trouble attracting
bidders; yet contractors were beating on the door to get work from Consolidated
Edison, the local utility. Why? First, the city was a notoriously slow payer, COs
(change orders) years behind, decision process chaotic, and payments made 60 days
after close of estimate. Con Edison paid on the 20th of the month for work done to
the first of the month. Change orders negotiated and paid within 30 days-60 days. If
a decision was needed, it came in 10 days. The number of bids you receive on your
projects are one measure of your administrative efficiency. Further, competition is
bound to give you the lowest possible construction price.

Even after bids are received and contracts signed, delays in payments may form the
basis for a successful claim against an agency on the part of the contractor.

250
The owner of a constructed facility usually has a better credit rating and can secure
loans at a lower borrowing rate, but there are some notable exceptions to this rule,
particularly for construction projects in developing countries. Under certain
circumstances, it is advisable for the owner to advance periodic payments to the
contractor in return for some concession in the contract price. This is particularly
true for large-scale construction projects with long durations for which financing
costs and capital requirements are high. If the owner is willing to advance these
amounts to the contractor, the gain in lower financing costs can be shared by both
parties through prior agreement.

Unfortunately, the choice of financing during the construction period is often left to
the contractor who cannot take advantage of all available options alone. The owner
is often shielded from participation through the traditional method of price
quotation for construction contracts. This practice merely exacerbates the problem
by excluding the owner from participating in decisions which may reduce the cost
of the project.

Under conditions of economic uncertainty, a premium to hedge the risk must be

added to the estimation of construction cost by both the owner and the contractor.
The larger and longer the project is, the greater is the risk. For an unsophisticated
owner who tries to avoid all risks and to place the financing burdens of
construction on the contractor, the contract prices for construction facilities are
likely to be increased to reflect the risk premium charged by the contractors. In
dealing with small projects with short durations, this practice may be acceptable
particularly when the owner lacks any expertise to evaluate the project financing
alternatives or the financial stability to adopt innovative financing schemes.
However, for large scale projects of long duration, the owner cannot escape the
responsibility of participation if it wants to avoid catastrophes of run-away costs
and expensive litigation. The construction of nuclear power plants in the private
sector and the construction of transportation facilities in the public sector offer
ample examples of such problems. If the responsibilities of risk sharing among
various parties in a construction project can be clearly defined in the planning
stage, all parties can be benefited to take advantage of cost saving and early use of
the constructed facility.

Example 7-13: Effects of payment delays

Table 7-9 shows an example of the effects of payment timing on the general
contractor and subcontractors. The total contract price for this project is $5,100,000
with scheduled payments from the owner shown in Column 2. The general
contractor's expenses in each period over the lifetime of the project are given in
Column 3 while the subcontractor's expenses are shown in Column 4. If the general
contractor must pay the subcontractor's expenses as well as its own at the end of
each period, the net cash flow of the general contractor is obtained in Column 5,
and its cumulative cash flow in Column 6.

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TABLE 7-9 An Example of the Effects of Payment Timing
General General
Owner Contractor's Subcontractor's Contractor's Cumulative
Period Payments Expenses Expenses Net Cash Flow Cash Flow
1 --- $100,000 $900,000 - $1,000,000 - $1,000,000
2 $950,000 100,000 900,000 - 50,000 - 1,050,000
3 950,000 100,000 900,000 - 50,000 - 1,100,000
4 950,000 100,000 900,000 - 50,000 - 1,150,000
5 950,000 100,000 900,000 - 50,000 - 1,200,000
6 1,300,000 - - 1,300,000 100,000
Total $5,100,000 $500,000 $4,500,000 $100,000

Note: Cumulative cash flow includes no financing charges.

In this example, the owner withholds a five percent retainage on cost as well as a
payment of $100,000 until the completion of the project. This $100,000 is equal to
the expected gross profit of the contractor without considering financing costs or
cash flow discounting. Processing time and contractual agreements with the owner
result in a delay of one period in receiving payments. The actual construction
expenses from the viewpoint of the general contractor consist of $100,000 in each
construction period plus payments due to subcontractors of $900,000 in each
period. While the net cash flow without regard to discounting or financing is equal
to a $100,000 profit for the general contractor, financial costs are likely to be
substantial. With immediate payment to subcontractors, over $1,000,000 must be
financed by the contractor throughout the duration of the project. If the general
contractor uses borrowing to finance its expenses, a maximum borrowing amount
of $1,200,000 in period five is required even without considering intermediate
interest charges. Financing this amount is likely to be quite expensive and may
easily exceed the expected project profit.

By delaying payments to subcontractors, the general contractor can substantially

reduce its financing requirement. For example, Table 7-10 shows the resulting cash
flows from delaying payments to subcontractors for one period and for two periods,
respectively. With a one period delay, a maximum amount of $300,000 (plus
intermediate interest charges) would have to be financed by the general contractor.
That is, from the data in Table 7-10, the net cash flow in period 1 is -$100,000, and
the net cash flow for each of the periods 2 through 5 is given by:

$950,000 - $100,000 - $900,000 = -$ 50,000

Finally, the net cash flow for period 6 is:
$1,300,000 - $900,000 = $400,000

Thus, the cumulative net cash flow from periods 1 through 5 as shown in Column 2
of Table 7-10 results in maximum shortfall of $300,000 in period 5 in Column 3.

252
For the case of a two period payment delay to the subcontractors, the general
contractor even runs a positive balance during construction as shown in Column 5.
The positive balance results from the receipt of owner payments prior to
reimbursing the subcontractor's expenses. This positive balance can be placed in an
interest bearing account to earn additional revenues for the general contractor.
Needless to say, however, these payment delays mean extra costs and financing
problems to the subcontractors. With a two period delay in payments from the
general contractor, the subcontractors have an unpaid balance of $1,800,000, which
would represent a considerable financial cost.

TABLE 7-10 An Example of the Cash Flow Effects of Delayed Payments

One Period Payment Delay Two Period Payment Delay
Period Net Cash Flow Cumulative Cash Flow Net Cash Flow Cumulative Cash Flow
1 - $100,000 - $100,000 - $100,000 - $100,000
2 - 50,000 - 150,000 850,000 750,000
3 - 50,000 - 200,000 - 50,000 700,000
4 - 50,000 - 250,000 - 50,000 650,000
5 - 50,000 - 300,000 - 50,000 600,000
6 400,000 100,000 400,000 1,000,000
7 - 900,000 100,000

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7.9 Construction Financing for Contractors

For a general contractor or subcontractor, the cash flow profile of expenses and
incomes for a construction project typically follows the work in progress for which
the contractor will be paid periodically. The markup by the contractor above the
estimated expenses is included in the total contract price and the terms of most
contracts generally call for monthly reimbursements of work completed less
retainage. At time period 0, which denotes the beginning of the construction
contract, a considerable sum may have been spent in preparation. The contractor's
expenses which occur more or less continuously for the project duration are
depicted by a piecewise continuous curve while the receipts (such as progress
payments from the owner) are represented by a step function as shown in Fig. 7-1.
The owner's payments for the work completed are assumed to lag one period
behind expenses except that a withholding proportion or remainder is paid at the
end of construction. This method of analysis is applicable to realistic situations
where a time period is represented by one month and the number of time periods is
extended to cover delayed receipts as a result of retainage.

253
Figure 7-1 Contractor's Expenses and Owner's Payments

While the cash flow profiles of expenses and receipts are expected to vary for
different projects, the characteristics of the curves depicted in Fig. 7-1 are
sufficiently general for most cases. Let Et represent the contractor's expenses in
period t, and Pt represent owner's payments in period t, for t=0,1,2,...,n for n=5 in
this case. The net operating cash flow at the end of period t for t 0 is given by:

(7.17)

254
where At is positive for a surplus and negative for a shortfall.

The cumulative operating cash flow at the end of period t just before receiving
payment Pt (for t 1) is:

(7.18)

where Nt-1 is the cumulative net cash flows from period 0 to period (t-1).
Furthermore, the cumulative net operating cash flow after receiving payment Pt at
the end of period t (for t 1) is:

(7.19)

The gross operating profit G for a n-period project is defined as net operating cash
flow at t=n and is given by:

(7.20)

The use of Nn as a measure of the gross operating profit has the disadvantage that it
is not adjusted for the time value of money.

Since the net cash flow At (for t=0,1,...,n) for a construction project represents the
amount of cash required or accrued after the owner's payment is plowed back to the
project at the end of period t, the internal rate of return (IRR) of this cash flow is
often cited in the traditional literature in construction as a profit measure. To
compute IRR, let the net present value (NPV) of At discounted at a discount rate i
per period be zero, i.e.,

(7.21)

The resulting i (if it is unique) from the solution of Eq. (7.21) is the IRR of the net
cash flow At. Aside from the complications that may be involved in the solution of
Eq. (7.21), the resulting i = IRR has a meaning to the contractor only if the firm
finances the entire project from its own equity. This is seldom if ever the case since
most construction firms are highly leveraged, i.e. they have relatively small equity
in fixed assets such as construction equipment, and depend almost entirely on
borrowing in financing individual construction projects. The use of the IRR of the

255
net cash flows as a measure of profit for the contractor is thus misleading. It does
not represent even the IRR of the bank when the contractor finances the project
through overdraft since the gross operating profit would not be given to the bank.

Since overdraft is the most common form of financing for small or medium size
projects, we shall consider the financing costs and effects on profit of - the use of
overdrafts. Let be the cumulative cash flow before the owner's payment in
period t including interest and be the cumulative net cash flow in period
t including interest. At t = 0 when there is no accrued interest, = F0 and =
N0. For t in period t can be obtained by considering the contractor's expensesI
Et to be dispersed uniformly during the period.

The inclusion of enterest on contractor's expenses Et during period t (for G 1) is

based on the rationale that the S-shaped curve depicting the contractor's expenses in
Figure 7-1 is fairly typical of actual situations, where the owner's payments are
typically made at the end of well defined periods. Hence, interest on expenses
during period t is approximated by one half of the amount as if the expenses were
paid at the beginning of the period. In fact, Et is the accumulation of all expenses in
period t and is treated - as an expense at the end of the period. Thus, the interest per
period (for t 1) is the combination of interest charge for Nt-1 in period t and
that for one half of Et in the same period t. If is negative and i is the borrowing
rate for the shortfall,

(7.22)

If is positive and h is the investment rate for the surplus,

(7.23)

Hence, if the cumulative net cash flow is negative, the interest on the overdraft
for each period t is paid by the contractor at the end of each period. If N t is positive,
a surplus is indicated and the subsequent interest would be paid to the contractor.
Most often, Nt is negative during the early time periods of a project and becomes
positive in the later periods when the contractor has received payments exceeding
expenses.

256
Including the interest accrued in period t, the cumulative cash flow at the end of
period t just before receiving payment Pt (for t 1) is:

(7.24)

Furthermore, the cumulative net cash flow after receiving payment Pt at the end of
period t (for t 1) is:

(7.25)

The gross operating profit at the end of a n-period project including interest
charges is:

(7.26)

where is the cumulative net cash flow for t = n.

Example 7-14: Contractor's gross profit from a project

The contractor's expenses and owner's payments for a multi-year construction

project are given in Columns 2 and 3, respectively, of Table 7-11. Each time period
is represented by one year, and the annual interest rate i is for borrowing 11%. The
computation has been carried out in Table 7-11, and the contractor's gross profit G
is found to be N5 = $8.025 million in the last column of the table.
TABLE 7-11 Example of Contractor's Expenses and Owner's Payments ($ Million)
Cumulative
Cash
Contractor's Owner's Net Cash Before Cumulative Net
Period Expenses Payments Flow Payments Cash
t Et Pt At Ft Nt
0 $3.782 $0 -$3.782 -$3.782 -$3.782
1 7.458 6.473 -0.985 -11.240 -4.767
2 10.425 9.334 -1.091 -15.192 -5.858
3 14.736 13.348 -1.388 -20.594 -7.246
4 11.420 16.832 +5.412 -18.666 -1.834
5 5.679 15.538 +9.859 -7.513 +8.025

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Total $53.500 $61.525 +$8.025

Example 7-15: Effects of Construction Financing

The computation of the cumulative cash flows including interest charges at i = 11%
for Example 7-14 is shown in Table 7-12 with gross profit = = $1.384
million. The results of computation are also shown in Figure 7-2.
TABLE 7-12 Example Cumulative Cash Flows Including Interests for a Contractor ($
Million)
Cumulative
Annual Before Cumulative
Period Construction Owner's
Interest Payments Net Cash Flow
(year) Expenses Payments
t Et Pt
0 $3.782 0 0 -$3.782 -$3.782
1 7.458 $6.473 -$0.826 -12.066 -5.593
2 10.425 9.334 -1.188 -17.206 -7.872
3 14.736 13.348 -1.676 -24.284 -10.936
4 11.420 16.832 -1.831 -24.187 -7.354
5 5.679 15.538 -1.121 -14.154 +1.384

258
Figure 7-2 Effects of Overdraft Financing

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7.10 Effects of Other Factors on a Contractor's Profits

In times of economic uncertainty, the fluctuations in inflation rates and market
interest rates affect profits significantly. The total contract price is usually a
composite of expenses and payments in then-current dollars at different payment
periods. In this case, estimated expenses are also expressed in then-current dollars.

259
During periods of high inflation, the contractor's profits are particularly vulnerable
to delays caused by uncontrollable events for which the owner will not be
responsible. Hence, the owner's payments will not be changed while the
contractor's expenses will increase with inflation.

Example 7-16: Effects of Inflation

Suppose that both expenses and receipts for the construction project in the Example
7-14 are now expressed in then-current dollars (with annual inflation rate of 4%) in
Table 7-13. The market interest rate reflecting this inflation is now 15%. In
considering these expenses and receipts in then-current dollars and using an interest
rate of 15% including inflation, we can recompute the cumulative net cash flow
(with interest). Thus, the gross profit less financing costs becomes = = $0.4
million. There will be a loss rather than a profit after deducting financing costs and
adjusting for the effects of inflation with this project.
TABLE 7-13 Example of Overdraft Financing Based on Inflated Dollars ($ Million)
Cumulative
Annual Before Cumulative
Period Construction Owner's
Interest Payments Net Cash Flow
(year) Expenses Payments
t Et Pt
0 $3.782 0 0 -$3.782 -$3.782
1 7.756 $6.732 -$1.149 -12.687 -5.955
2 11.276 10.096 -1.739 -18.970 -8.874
3 16.576 15.015 -2.574 -28.024 -13.009
4 13.360 16.691 -2.953 -29.322 -9.631
5 6.909 18.904 -1.964 -18.504 +0.400

Example 7-17: Effects of Work Stoppage at Periods of Inflation

Suppose further that besides the inflation rate of 4%, the project in Example 7-16 is
suspended at the end of year 2 due to a labor strike and resumed after one year.
Also, assume that while the contractor will incur higher interest expenses due to the
work stoppage, the owner will not increase the payments to the contractor. The
cumulative net cash flows for the cases of operation and financing expenses are
recomputed and tabulated in Table 7-14. The construction expenses and receipts in
then-current dollars resulting from the work stopping and the corresponding net
cash flow of the project including financing (with annual interest accumulated in
the overdraft to the end of the project) is shown in Fig. 7-3. It is noteworthy that,
with or without the work stoppage, the gross operating profit declines in value at
the end of the project as a result of inflation, but with the work stoppage it has
eroded - further to a loss of $3.524 million as indicated by = -3.524 in Table 7-
14.

260
TABLE 7-14 Example of the Effects of Work Stoppage and Inflation on a Contractor ($
Million)
Cumulative
Annual Before Cumulative
Period Construction Owner's
Interest Payments Net Cash Flow
(year) Expenses Payments
t Et Pt
0 $3.782 0 0 -$3.782 -$3.782
1 7.756 $6.732 -$1.149 -12.687 -5.955
2 11.276 10.096 -1.739 -18.970 -8.874
3 0 0 -1.331 -10.205 -10.205
4 17.239 15.015 -2.824 -30.268 -15.253
5 13.894 16.691 -3.330 -32.477 -12.786
6 7.185 18.904 -2.457 22.428 -3.524

261
Figure 7-3 Effects of Inflation and Work Stoppage

Example 7-18: Exchange Rate Fluctuation. Contracting firms engaged in

international practice also face financial issues associated with exchange rate
fluctuations. Firms are typically paid in local currencies, and the local currency
may loose value relative to the contractor's home currency. Moreover, a
construction contractor may have to purchase component parts in the home
currency. Various strategies can be used to reduce this exchange rate risk,
including:

262
 • Pooling expenses and incomes from multiple projects to reduce the amount
of currency exchanged.
• Purchasing futures contracts to exchange currency at a future date at a
guaranteed rate. If the exchange rate does not change or changes in a
favorable direction, the contractor may decide not to exercise or use the
futures contract.
• Borrowing funds in local currencies and immediately exchanging the
expected profit, with the borrowing paid by eventual payments from the
owner.

Back to top

7.11 References
1. Au, T., and C. Hendrickson, "Profit Measures for Construction
Projects," ASCE Journal of Construction Engineering and Management,
Vol. 112, No. CO-2, 1986, pp. 273-286.
2. Brealey, R. and S. Myers, Principles of Corporate Finance, McGraw-Hill,
Sixth Edition, 2002.
3. Collier, C.A. and D.A. Halperin, Construction Funding: Where the Money
Comes From, Second Edition, John Wiley and Sons, New York, 1984.
4. Dipasquale, D. and C. Hendrickson, "Options for Financing a Regional
Transit Authority," Transportation Research Record, No. 858, 1982, pp. 29-
35.
5. Kapila, Prashant and Chris Hendrickson, "Exchange Rate Risk Management
in International Construction Ventures," ASCE J. of Construction Eng. and
Mgmt, 17(4), October 2001.
6. Goss, C.A., "Financing: The Contractor's Perspective," Construction
Contracting, Vol. 62, No. 10, pp. 15-17, 1980.

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7.12 Problems
1. Compute the effective annual interest rate with a nominal annual rate of 12%
and compounding periods of:
1. monthly,
2. quarterly, and
3. semi-annually (i.e. twice a year).

263
2. A corporation is contemplating investment in a facility with the following
before-tax operating cash flow (in thousands of constant dollars) at year
ends:

Year 0 1 2 3 4 5 6 7
Cash Flow -$500 $110 $112 $114 $116 $118 $120 $122
3. The MARR of the corporation before tax is 10%. The corporation will
finance the facility by using $200,000 from retained earning and by
borrowing the remaining amount through one of the following two plans:
1. A seven year coupon bond with 5% issuance cost and 12% interest
rate payable annually.
2. Overdraft from a bank at 13% interest

Which financing plan is preferable?

4. Suppose that an overseas constructor proposed to build the facility in

Problem P7-2 at a cost of $550,000 (rather than $500,000), but would also
arrange financing with a 5% issuing charge and uniform payments over a
seven year period. This financing is available from an export bank with a
special interest rate of 9%. Is this offer attractive?

5. The original financing arrangement to obtain a $550,000 loan for a seven

year project with 5% issuing charge is to repay both the loan and issue
charge through uniform annual payments with a 9% annual interest rate over
the seven year period. If this arrangement is to be refinanced after 2 years by
coupon bonds which pays 8% nominal annual interest (4% per 6-month
period) for the remaining 5 years at the end of which the principal will be
due. Assuming an origination fee of 2%, determine the total amount of
coupon bonds necessary for refinancing, and the interest payment per
period.

6. A public agency is contemplating construction of a facility with the

following operating cash flow (in thousands of constant dollars) at year
ends.

Year 0 1 2 3 4 5
Cash Flow -$400 -$200 $280 $300 $320 $340
7. The MARR of the agency is 10% including inflation. If the agency can
financing this facility in one of the following two ways, which financing
scheme is preferable?
1. Overdraft financing at an interest rate of 12% per annum.
2. Five year coupon bonds (so that all principal is repaid at the end of
year 5) in the amount of $672,000 including an issuing cost of 5% and
at a 10% interest rate.

264
8. Suppose that the coupon bonds in Problem 5 are to be refinanced after two
years by a uniform payment mortgage for the remaining three years, for an
issuing cost of $10,000 in then-current dollars. If the mortgage is repaid with
uniform monthly payments for 36 months and the monthly interest rate is
1%, determine the amount of monthly payment.

9. Suppose the investment in a facility by a public agency results in a net

operating cash flow at year ends (in thousands of dollars) as follows:

Year 0 1 2 3 4 5 6
Cash Flow -$850 -$250 $250 $250 $450 $450 $450
10.The agency has a MARR of 9% and is not subject to tax. If the project can
be financed in one of the two following ways, which financing scheme is
preferable?
1. Six-year uniform payment bonds at 11% interest rate for a total
amount of borrowing of $875,000 which includes $25,000 of issuing
cost.
2. Five year coupon bonds at 10% interest rate for a total amount of
borrowing of $900,000 which includes $50,000 of issuing cost.

11. Suppose that the five year coupon bond in Problem 7 is to be

refinanced, after the payment of interest at the end of year 3, by a uniform
mortgage which requires an issuance cost of 2%. If the annual interest rate is
9%, what is the uniform annual payment on the mortgage for another 5
years.

12. A corporation plans to invest in a small project which costs a one-time

expenditure of $700,000 and offers an annual return of $250,000 each in the
next four years. It intends to finance this project by issuing a five year
promissory note which requires an origination fee of $10,000. Interest
payments are made annually at 9% with the repayment of the principal at the
end of five years. If the before tax MARR of the Corporation is 11%, find
the adjusted net present value of the investment in conjunction with the
proposed financing.

13. A local transportation agency is receiving a construction grant in annual

installments from the federal and state governments for a construction
project. However, it must make payments to the contractor periodically for
construction expenditures. Suppose that all receipts and expenditures (in
million dollars) are made at year ends as shown below. Determine the

265
 overdraft at the end of year 5 if the project is financed with an overdraft at an
annual interest rate of 10%.

Year 0 1 2 3 4 5
Receipts 0 $4.764 $7.456 $8.287 $6.525 $2.468
Expenditures $1.250 $6.821 9.362 7.744 4.323 0
14. The operating cash flows of contractor's expenses and the owner's payments
for a construction project as stipulated in the contract agreement are shown
in Table 7-15. The contractor has established a line of credit from the bank at
a monthly interest rate of 1.5%, and the contractor is allowed to borrow the
shortfall between expense and receipt at the end of each month but must
deposit any excess of net operating cash flow to reduce the loan amount.
Assuming that there is no inflation, determine the cumulative net cash flow
including interest due to overdrafting. Also find the contractor's gross profit.
Table 7-15
End of Month Contractor's Expenses Owner's Payments
0 -$200,000 0
1 -250,000 $225,000
2 -400,000 360,000
3 -520,000 468,000
4 -630,000 567,000
5 -780,000 702,000
6 -750,000 675,000
7 -660,000 594,000
8 -430,000 387,000
9 -380,000 342,000
10 -332,000 298,800
11 -256,000 230,400
12 -412,000 370,800
13 0 1,080,000
14 0 600,000
Total $6,000,000 6,900,000
15.

16.Suppose that both contractor's expenses and owner's receipts for a

construction project are expressed in then-current inflated dollars in Table 7-
16. Suppose also that the monthly interest rate required by the bank is 1.5%.
Suppose that the work is stopped for two months at the end of month 5 due
to labor strike while the monthly inflation rate is 0.5%. Under the terms of
the contract between the owner and the contractor, suppose that the owner's
payments will be delayed but not adjusted for inflation. Find the cumulative
net cash flow with interest due to overdrafting.
Table 7-16
End of Month Contractor's Expenses Owner's Payments
0 -$200,000 0
1 -251,250 $225,000

266
 2 -404,000 360,000
3 -527,852 468,000
4 -642,726 567,000
5 -799,734 702,000
6 -772,800 675,000
7 -683,430 594,000
8 -447,501 387,000
9 -397,442 342,000
10 -348,965 298,800
11 -270,438 230,400
12 -437,420 370,800
13 0 1,080,000
14 0 600,000
Total -$6,183,558 6,900,000
17.

18. The contractor's construction expenses and the owner's payments for a
construction project in then-current dollars as stipulated in the contract
agreement are shown in Table 7-17. The contractor has established a line of
credit from the bank at a monthly interest rate of 2% (based on then-current
dollars), and the contractor is allowed to borrow the shortfalls between
expense and receipt at the end of each month but must deposit any excess of
net operating cash flow to reduce the loan amount. Determine the cumulative
net cash flow including interest due to overdrafting. Also, find the
contractor's gross profit.
Table 7-17
End of Month Contractor's Expenses Owner's Payments
0 $50,000 0
1 85,000 $47,500
2 176,000 80,700
3 240,000 167,200
4 284,000 228,000
5 252,000 270,000
6 192,000 237,500
7 123,000 182,400
8 98,000 116,800
9 0 319,900
Total -$1,500,000 1,650,000
19.

20.Suppose that both the contractor's expenses and owner's payments for a
construction project are expressed in then-current dollars in Table 7-17
(Problem 13). The monthly interest rate required by the bank is 2.5% based
on then-current dollars. Suppose that the work is stopped for three months at
the end of month 4 due to a labor strike while the monthly inflation rate is
0.5%. The owner's payments will be delayed but not adjusted for inflation.

267
 Find the cumulative net cash flow expressed in then-current dollars, with
interest compounded and accumulated to the end of the project.

Back to top

7.13 Footnotes
1. This table is adapted from A.J. Henkel, "The Mechanics of a Revenue Bond
Financing: An Overview," Infrastructure Financing, Kidder, Peabody & Co., New
York, 1984. (Back)

2. The calculations for this bond issue are adapted from a hypothetical example in
F. H. Fuller, "Analyzing Cash Flows for Revenue Bond Financing," Infrastructure
Financing, Kidder, Peabody & Co., Inc., New York, 1984, pp. 37-47. (Back)

3. Maevis, Alfred C.,"Construction Cost Control by the Owner," ASCE Journal of

the Construction Division, Vol. 106, No. 4, December, 1980, pg. 444. (Back)

268
8. Construction Pricing and Contracting
8.1 Pricing for Constructed Facilities
Because of the unique nature of constructed facilities, it is almost imperative to
have a separate price for each facility. The construction contract price includes the
direct project cost including field supervision expenses plus the markup imposed by
contractors for general overhead expenses and profit. The factors influencing a
facility price will vary by type of facility and location as well. Within each of the
major categories of construction such as residential housing, commercial buildings,
industrial complexes and infrastructure, there are smaller segments which have
very different environments with regard to price setting. However, all pricing
arrangements have some common features in the form of the legal documents
binding the owner and the supplier(s) of the facility. Without addressing special
issues in various industry segments, the most common types of pricing
arrangements can be described broadly to illustrate the basic principles.

Competitive Bidding

The basic structure of the bidding process consists of the formulation of detailed
plans and specifications of a facility based on the objectives and requirements of
the owner, and the invitation of qualified contractors to bid for the right to execute
the project. The definition of a qualified contractor usually calls for a minimal
evidence of previous experience and financial stability. In the private sector, the
owner has considerable latitude in selecting the bidders, ranging from open
competition to the restriction of bidders to a few favored contractors. In the public
sector, the rules are carefully delineated to place all qualified contractors on an
equal footing for competition, and strictly enforced to prevent collusion among
contractors and unethical or illegal actions by public officials.

Detailed plans and specifications are usually prepared by an

architectural/engineering firm which oversees the bidding process on behalf of the
owner. The final bids are normally submitted on either a lump sum or unit price
basis, as stipulated by the owner. A lump sum bid represents the total price for
which a contractor offers to complete a facility according to the detailed plans and
specifications. Unit price bidding is used in projects for which the quantity of
materials or the amount of labor involved in some key tasks is particularly
uncertain. In such cases, the contractor is permitted to submit a list of unit prices
for those tasks, and the final price used to determine the lowest bidder is based on
the lump sum price computed by multiplying the quoted unit price for each
specified task by the corresponding quantity in the owner's estimates for quantities.
However, the total payment to the winning contractor will be based on the actual
quantities multiplied by the respective quoted unit prices.

269
Negotiated Contracts

Instead of inviting competitive bidding, private owners often choose to award

construction contracts with one or more selected contractors. A major reason for
using negotiated contracts is the flexibility of this type of pricing arrangement,
particularly for projects of large size and great complexity or for projects which
substantially duplicate previous facilities sponsored by the owner. An owner may
value the expertise and integrity of a particular contractor who has a good
reputation or has worked successfully for the owner in the past. If it becomes
necessary to meet a deadline for completion of the project, the construction of a
project may proceed without waiting for the completion of the detailed plans and
specifications with a contractor that the owner can trust. However, the owner's staff
must be highly knowledgeable and competent in evaluating contractor proposals
and monitoring subsequent performance.

Generally, negotiated contracts require the reimbursement of direct project cost

plus the contractor's fee as determined by one of the following methods:

1. Cost plus fixed percentage

2. Cost plus fixed fee
3. Cost plus variable fee
4. Target estimate
5. Guaranteed maximum price or cost

The fixed percentage or fixed fee is determined at the outset of the project, while
variable fee and target estimates are used as an incentive to reduce costs by sharing
any cost savings. A guaranteed maximum cost arrangement imposes a penalty on a
contractor for cost overruns and failure to complete the project on time. With a
guaranteed maximum price contract, amounts below the maximum are typically
shared between the owner and the contractor, while the contractor is responsible for
costs above the maximum.

Speculative Residential Construction

In residential construction, developers often build houses and condominiums in

anticipation of the demand of home buyers. Because the basic needs of home
buyers are very similar and home designs can be standardized to some degree, the
probability of finding buyers of good housing units within a relatively short time is
quite high. Consequently, developers are willing to undertake speculative building
and lending institutions are also willing to finance such construction. The developer
essentially set the price for each housing unit as the market will bear, and can adjust
the prices of remaining units at any given time according to the market trend.

Force-Account Construction

270
Some owners use in-house labor forces to perform a substantial amount of
construction, particularly for addition, renovation and repair work. Then, the total
of the force-account charges including in-house overhead expenses will be the
pricing arrangement for the construction.

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8.2 Contract Provisions for Risk Allocation

Provisions for the allocation of risk among parties to a contract can appear in
numerous areas in addition to the total construction price. Typically, these
provisions assign responsibility for covering the costs of possible or unforeseen
occurances. A partial list of responsibilities with concomitant risk that can be
assigned to different parties would include:

• Force majeure (i.e., this provision absolves an owner or a contractor for

payment for costs due to "Acts of God" and other external events such as
war or labor strikes)
• Indemnification (i.e., this provision absolves the indemified party from any
payment for losses and damages incurred by a third party such as adjacent
property owners.)
• Liens (i.e., assurances that third party claims are settled such as "mechanics
liens" for worker wages),
• Labor laws (i.e., payments for any violation of labor laws and regulations on
the job site),
• Differing site conditions (i.e., responsibility for extra costs due to
unexpected site conditions),
• Delays and extensions of time,
• Liquidated damages (i.e., payments for any facility defects with payment
amounts agreed to in advance)
• Consequential damages (i.e., payments for actual damage costs assessed
upon impact of facility defects),
• Occupational safety and health of workers,
• Permits, licenses, laws, and regulations,
• Equal employment opportunity regulations,
• Termination for default by contractor,
• Suspension of work,
• Warranties and guarantees.

The language used for specifying the risk assignments in these areas must conform
to legal requirements and past interpretations which may vary in different
jurisdictions or over time. Without using standard legal language, contract
provisions may be unenforceable. Unfortunately, standard legal language for this
purpose may be difficult to understand. As a result, project managers often have
difficulty in interpreting their particular responsibilities. Competent legal counsel is

271
required to advise the different parties to an agreement about their respective
responsibilities.

Standard forms for contracts can be obtained from numerous sources, such as the
American Institute of Architects (AIA) or the Associated General Contractors
(AGC). These standard forms may include risk and responsibility allocations which
are unacceptable to one or more of the contracting parties. In particular, standard
forms may be biased to reduce the risk and responsibility of the originating
organization or group. Parties to a contract should read and review all contract
documents carefully.

The three examples appearing below illustrate contract language resulting in

different risk assignments between a contractor (CONTRACTOR) and an owner
(COMPANY). Each contract provision allocates different levels of indemnification
risk to the contractor. [1]

Example 8-1: A Contract Provision Example with High Contractor Risk

"Except where the sole negligence of COMPANY is involved or alleged,

CONTRACTOR shall indemnify and hold harmless COMPANY, its officers,
agents and employees, from and against any and all loss, damage, and liability and
from any and all claims for damages on account of or by reason of bodily injury,
including death, not limited to the employees of CONTRACTOR, COMPANY,
and of any subcontractor or CONTRACTOR, and from and against any and all
damages to property, including property of COMPANY and third parties, direct
and/or consequential, caused by or arising out of, in while or in part, or claimed to
have been caused by or to have arisen out of, in whole or in part, an act of omission
of CONTRACTOR or its agents, employees, vendors, or subcontractors, of their
employees or agents in connection with the performance of the Contract
Documents, whether or not insured against; and CONTRACTOR shall, at its own
cost and expense, defend any claim, suit, action or proceeding, whether groundless
or not, which may be commenced against COMPANY by reason thereof or in
connection therewith, and CONTRACTOR shall pay any and all judgments which
may be recovered in such action, claim, proceeding or suit, and defray any and all
expenses, including costs and attorney's fees which may be incurred by reason of
such actions, claims, proceedings, or suits."

Comment: This is a very burdensome provision for the contractor. It makes the
contractor responsible for practically every conceivable occurrence and type of
damage, except when a claim for loss or damages is due to the sole negligence of
the owner. As a practical matter, sole negligence on a construction project is very
difficult to ascertain because the work is so inter-twined. Since there is no dollar
limitation to the contractor's exposure, sufficient liability coverage to cover worst
scenario risks will be difficult to obtain. The best the contractor can do is to obtain
as complete and broad excess liability insurance coverage as can be purchased.

272
This insurance is costly, so the contractor should insure the contract price is
sufficiently high to cover the expense.

Example 8-2: An Example Contract Provision with Medium Risk Allocation to

Contractor

"CONTRACTOR shall protect, defend, hold harmless, and indemnify COMPANY

from and against any loss, damage, claim, action, liability, or demand whatsoever
(including, with limitation, costs, expenses, and attorney's fees, whether for appeals
or otherwise, in connection therewith), arising out of any personal injury
(including, without limitation, injury to any employee of COMPANY,
CONTRACTOR or any subcontractor), arising out of any personal injury
(including, without limitation, injury to any employee of COMPANY,
CONTRACTOR, or any subcontractor), including death resulting therefrom or out
of any damage to or loss or destruction of property, real and or personal (including
property of COMPANY, CONTRACTOR, and any subcontractor, and including
tools and equipment whether owned, rented, or used by CONTRACTOR, any
subcontractor, or any workman) in any manner based upon, occasioned by , or
attributable or related to the performance, whether by the CONTRACTOR or any
subcontractor, of the Work or any part thereof, and CONTRACTOR shall at its
own expense defend any and all actions based thereon, except where said personal
injury or property damage is caused by the negligence of COMPANY or
COMPANY'S employees. Any loss, damage, cost expense or attorney's fees
incurred by COMPANY in connection with the foregoing may, in addition to other
remedies, be deducted from CONTRACTOR'S compensation, then due or
thereafter to become due. COMPANY shall effect for the benefit of CONTRACTOR
a waiver of subrogation on the existing facilities, including consequential damages
such as, but not by way of limitation, loss of profit and loss of product or plant
downtime but excluding any deductibles which shall exist as at the date of this
CONTRACT; provided, however, that said waiver of subrogation shall be
expanded to include all said deductible amounts on the acceptance of the Work by
COMPANY."

Comment: This clause provides the contractor considerable relief. He still has
unlimited exposure for injury to all persons and third party property but only to the
extent caused by the contractor's negligence. The "sole" negligence issue does not
arise. Furthermore, the contractor's liability for damages to the owner's property-a
major concern for contractors working in petrochemical complexes, at times worth
billions-is limited to the owner's insurance deductible, and the owner's insurance
carriers have no right of recourse against the contractor. The contractor's limited
exposure regarding the owner's facilities ends on completion of the work.

Example 8-3: An Example Contract Provision with Low Risk Allocation to

Contractor

273
"CONTRACTOR hereby agrees to indemnify and hold COMPANY and/or any
parent, subsidiary, or affiliate, or COMPANY and/or officers, agents, or employees
of any of them, harmless from and against any loss or liability arising directly or
indirectly out of any claim or cause of action for loss or damage to property
including, but not limited to, CONTRACTOR'S property and COMPANY'S
property and for injuries to or death of persons including but not limited to
CONTRACTOR'S employees, caused by or resulting from the performance of the
work by CONTRACTOR, its employees, agents, and subcontractors and shall, at
the option of COMPANY, defend COMPANY at CONTRACTOR'S sole expense
in any litigation involving the same regardless of whether such work is performed
by CONTRACTOR, its employees, or by its subcontractors, their employees, or all
or either of them. In all instances, CONTRACTOR'S indemnity to COMPANY shall
be limited to the proceeds of CONTRACTOR'S umbrella liability insurance
coverage."

Comment: With respect to indemnifying the owner, the contractor in this provision
has minimal out-of-pocket risk. Exposure is limited to whatever can be collected
from the contractor's insurance company.

Back to top

8.3 Risks and Incentives on Construction Quality

All owners want quality construction with reasonable costs, but not all are willing
to share risks and/or provide incentives to enhance the quality of construction. In
recent years, more owners recognize that they do not get the best quality of
construction by squeezing the last dollar of profit from the contractor, and they
accept the concept of risk sharing/risk assignment in principle in letting
construction contracts. However, the implementation of such a concept in the past
decade has received mixed results.

Many public owners have been the victims of their own schemes, not only because
of the usual requirement in letting contracts of public works through competitive
bidding to avoid favoritism, but at times because of the sheer weight of entrenched
bureaucracy. Some contractors steer away from public works altogether; others
submit bids at higher prices to compensate for the restrictive provisions of contract
terms. As a result, some public authorities find that either there are few responsible
contractors responding to their invitations to submit bids or the bid prices far
exceed their engineers' estimates. Those public owners who have adopted the
federal government's risk sharing/risk assignment contract concepts have found that
while initial bid prices may have decreased somewhat, claims and disputes on
contracts are more frequent than before, and notably more so than in privately
funded construction. Some of these claims and disputes can no doubt be avoided by
improving the contract provisions. [2]

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Since most claims and disputes arise most frequently from lump sum contracts for
both public and private owners, the following factors associated with lump sum
contracts are particularly noteworthy:

• unbalanced bids in unit prices on which periodic payment estimates are

based.
• change orders subject to negotiated payments
• changes in design or construction technology
• incentives for early completion

An unbalanced bid refers to raising the unit prices on items to be completed in the
early stage of the project and lowering the unit prices on items to be completed in
the later stages. The purpose of this practice on the part of the contractor is to ease
its burden of construction financing. It is better for owners to offer explicit
incentives to aid construction financing in exchange for lower bid prices than to
allow the use of hidden unbalanced bids. Unbalanced bids may also occur if a
contractor feels some item of work was underestimated in amount, so that a high
unit price on that item would increase profits. Since lump sum contracts are
awarded on the basis of low bids, it is difficult to challenge the low bidders on the
validity of their unit prices except for flagrant violations. Consequently remedies
should be sought by requesting the contractor to submit pertinent records of
financial transactions to substantiate the expenditures associated with its monthly
billings for payments of work completed during the period.

One of the most contentious issues in contract provisions concerns the payment for
change orders. The owner and its engineer should have an appreciation of the
effects of changes for specific items of work and negotiate with the contractor on
the identifiable cost of such items. The owner should require the contractor to
submit the price quotation within a certain period of time after the issuance of a
change order and to assess whether the change order may cause delay damages. If
the contract does not contain specific provisions on cost disclosures for evaluating
change order costs, it will be difficult to negotiate payments for change orders and
claim settlements later.

In some projects, the contract provisions may allow the contractor to provide
alternative design and/or construction technology. The owner may impose different
mechanisms for pricing these changes. For example, a contractor may suggest a
design or construction method change that fulfills the performance requirements.
Savings due to such changes may accrue to the contractor or the owner, or may be
divided in some fashion between the two. The contract provisions must reflect the
owners risk-reward objectives in calling for alternate design and/or construction
technology. While innovations are often sought to save money and time,
unsuccessful innovations may require additional money and time to correct earlier
misjudgment. At worse, a failure could have serious consequences.

275
In spite of admonitions and good intentions for better planning before initiating a
construction project, most owners want a facility to be in operation as soon as
possible once a decision is made to proceed with its construction. Many
construction contracts contain provisions of penalties for late completion beyond a
specified deadline; however, unless such provisions are accompanied by similar
incentives for early completion, they may be ruled unenforceable in court. Early
completion may result in significant savings, particularly in rehabilitation projects
in which the facility users are inconvenienced by the loss of the facility and the
disruption due to construction operations.

Example 8-4: Arkansas Rice Growers Cooperative Association v. Alchemy

Industries

A 1986 court case can illustrate the assumption of risk on the part of contractors
and design professionals. [3] The Arkansas Rice Growers Cooperative contracted
with Alchemy Industries, Inc. to provide engineering and construction services for
a new facility intended to generate steam by burning rice hulls. Under the terms of
the contract, Alchemy Industries guaranteed that the completed plant would be
capable of "reducing a minimum of seven and one-half tons of rice hulls per hour to
an ash and producing a minimum of 48 million BTU's per hour of steam at 200
pounds pressure." Unfortunately, the finished plant did not meet this performance
standard, and the Arkansas Rice Growers Cooperative Association sued Alchemy
Industries and its subcontractors for breach of warranty. Damages of almost $1.5
million were awarded to the Association.
Back to top

8.4 Types of Construction Contracts

While construction contracts serve as a means of pricing construction, they also
structure the allocation of risk to the various parties involved. The owner has the
sole power to decide what type of contract should be used for a specific facility to
be constructed and to set forth the terms in a contractual agreement. It is important
to understand the risks of the contractors associated with different types of
construction contracts.

Lump Sum Contract

In a lump sum contract, the owner has essentially assigned all the risk to the
contractor, who in turn can be expected to ask for a higher markup in order to take
care of unforeseen contingencies. Beside the fixed lump sum price, other
commitments are often made by the contractor in the form of submittals such as a
specific schedule, the management reporting system or a quality control program. If
the actual cost of the project is underestimated, the underestimated cost will reduce
the contractor's profit by that amount. An overestimate has an opposite effect, but
may reduce the chance of being a low bidder for the project.

276
Unit Price Contract

In a unit price contract, the risk of inaccurate estimation of uncertain quantities for
some key tasks has been removed from the contractor. However, some contractors
may submit an "unbalanced bid" when it discovers large discrepancies between its
estimates and the owner's estimates of these quantities. Depending on the
confidence of the contractor on its own estimates and its propensity on risk, a
contractor can slightly raise the unit prices on the underestimated tasks while
lowering the unit prices on other tasks. If the contractor is correct in its assessment,
it can increase its profit substantially since the payment is made on the actual
quantities of tasks; and if the reverse is true, it can lose on this basis. Furthermore,
the owner may disqualify a contractor if the bid appears to be heavily unbalanced.
To the extent that an underestimate or overestimate is caused by changes in the
quantities of work, neither error will effect the contractor's profit beyond the
markup in the unit prices.

Cost Plus Fixed Percentage Contract

For certain types of construction involving new technology or extremely pressing

needs, the owner is sometimes forced to assume all risks of cost overruns. The
contractor will receive the actual direct job cost plus a fixed percentage, and have
little incentive to reduce job cost. Furthermore, if there are pressing needs to
complete the project, overtime payments to workers are common and will further
increase the job cost. Unless there are compelling reasons, such as the urgency in
the construction of military installations, the owner should not use this type of
contract.

Cost Plus Fixed Fee Contract

Under this type of contract, the contractor will receive the actual direct job cost
plus a fixed fee, and will have some incentive to complete the job quickly since its
fee is fixed regardless of the duration of the project. However, the owner still
assumes the risks of direct job cost overrun while the contractor may risk the
erosion of its profits if the project is dragged on beyond the expected time.

Cost Plus Variable Percentage Contract

For this type of contract, the contractor agrees to a penalty if the actual cost exceeds
the estimated job cost, or a reward if the actual cost is below the estimated job cost.
In return for taking the risk on its own estimate, the contractor is allowed a variable
percentage of the direct job-cost for its fee. Furthermore, the project duration is
usually specified and the contractor must abide by the deadline for completion.
This type of contract allocates considerable risk for cost overruns to the owner, but
also provides incentives to contractors to reduce costs as much as possible.

277
Target Estimate Contract

This is another form of contract which specifies a penalty or reward to a contractor,

depending on whether the actual cost is greater than or less than the contractor's
estimated direct job cost. Usually, the percentages of savings or overrun to be
shared by the owner and the contractor are predetermined and the project duration
is specified in the contract. Bonuses or penalties may be stipulated for different
project completion dates.

Guaranteed Maximum Cost Contract

When the project scope is well defined, an owner may choose to ask the contractor
to take all the risks, both in terms of actual project cost and project time. Any work
change orders from the owner must be extremely minor if at all, since performance
specifications are provided to the owner at the outset of construction. The owner
and the contractor agree to a project cost guaranteed by the contractor as maximum.
There may be or may not be additional provisions to share any savings if any in the
contract. This type of contract is particularly suitable for turnkey operation.

Back to top

8.5 Relative Costs of Construction Contracts

Regardless of the type of construction contract selected by the owner, the
contractor recognizes that the actual construction cost will never be identical to its
own estimate because of imperfect information. Furthermore, it is common for the
owner to place work change orders to modify the original scope of work for which
the contractor will receive additional payments as stipulated in the contract. The
contractor will use different markups commensurate with its market circumstances
and with the risks involved in different types of contracts, leading to different
contract prices at the time of bidding or negotiation. The type of contract agreed
upon may also provide the contractor with greater incentives to try to reduce costs
as much as possible. The contractor's gross profit at the completion of a project is
affected by the type of contract, the accuracy of its original estimate, and the nature
of work change orders. The owner's actual payment for the project is also affected
by the contract and the nature of work change orders.

In order to illustrate the relative costs of several types of construction contracts, the
pricing mechanisms for such construction contracts are formulated on the same
direct job cost plus corresponding markups reflecting the risks. Let us adopt the
following notation:

E=
contractor's original estimate of the direct job cost at the time of contract
award

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M=
amount of markup by the contractor in the contract
B=
estimated construction price at the time of signing contract
A=
contractor's actual cost for the original scope of work in the contract
U=
underestimate of the cost of work in the original estimate (with negative
value of U denoting an overestimate)
C=
additional cost of work due to change orders
P=
actual payment to contractor by the owner
F=
contractor's gross profit
R=
basic percentage markup above the original estimate for fixed fee contract
Ri =
premium percentage markup for contract type i such that the total percentage
markup is (R + Ri), e.g. (R + R1) for a lump sum contract, (R + R2) for a unit
price contract, and (R + R3) for a guaranteed maximum cost contract
N=
a factor in the target estimate for sharing the savings in cost as agreed upon
by the owner and the contractor, with 0 N 1.

At the time of a contract award, the contract price is given by:

(8.1)

The underestimation of the cost of work in the original contract is defined as:

(8.2)

Then, at the completion of the project, the contractor's actual cost for the original
scope of work is:

(8.3)

For various types of construction contracts, the contractor's markup and the price
for construction agreed to in the contract are shown in Table 8-1. Note that at the
time of contract award, it is assumed that A = E, even though the effects of

279
underestimation on the contractor's gross profits are different for various types of
construction contracts when the actual cost of the project is assessed upon its
completion.

TABLE 8-1 Original Estimated Contract Prices

Type of Contract Markup Contract Price
1. Lump sum M = (R +R1)E B = (1 + R + R1)E
2. Unit price M = (R + R2)E B = (1 + R + R2)E
3. Cost plus fixed % M = RA = RE B = (1 + R)E
4. Cost plus fixed fee M = RE B = (1 + R)E
5. Cost plus variable % M = R (2E - A) = RE B = (1 + R)E
6. Target estimate M = RE + N (E-A) = RE B = (1 + R)E
7. Guaranteed max cost M = (R + R3)E B = (1 + R + R3)E

Payments of change orders are also different in contract provisions for different
types of contracts. Suppose that payments for change orders agreed upon for
various types of contracts are as shown in column 2 of Table 8-2. The owner's
actual payments based on these provisions as well as the incentive provisions for
various types of contracts are given in column 3 of Table 8-2. The corresponding
contractor's profits under various contractual arrangements are shown in Table 8-3.

TABLE 8-2 Owner's Actual Payment with Different Contract Provisions

Type of Contract Change Order Payment Owner's Payment
1. Lump sum C(1 + R + R1) P = B + C(1 + R + R1)
2. Unit price C(1 + R + R2) P = (1 + R + R2)A + C
3. Cost plus fixed % C(1 + R) P = (1 + R)(A + C)
4. Cost plus fixed fee C P = RE + A + C
5. Cost plus variable % C(1 + R) P = R (2E - A + C) + A + C
6. Target estimate C P = RE + N (E - A) + A + C
7. Guaranteed max cost 0 P=B

TABLE 8-3 Contractor's Gross Profit with Different Contract Provisions

Type of Contract Profit from Change Order Contractor's Gross Profit
1. Lump sum C(R + R1) F = E - A + (R + R1)(E + C)
2. Unit price C(R + R2 F = (R + R2)(A + C)
3. Cost plus fixed % CR F = R (A + C)
4. Cost plus fixed fee 0 F = RE
5. Cost plus variable % CR F = R (2E - A + C)
6. Target estimate 0 F = RE + N (E - A)
7. Guaranteed max cost -C F = (1 + R + R3)E - A - C

It is important to note that the equations in Tables 8-1 through 8-3 are illustrative,
subject to the simplified conditions of payments assumed under the various types of

280
contracts. When the negotiated conditions of payment are different, the equations
must also be modified.

Example 8-5: Contractor's Gross Profits under Different Contract

Arrangements

Consider a construction project for which the contractor's original estimate is

$6,000,000. For various types of contracts, R = 10%, R 1 = 2%, R2 = 1%, R3 = 5%
and N = 0.5. The contractor is not compensated for change orders under the
guaranteed maximum cost contract if the total cost for the change orders is within
6% ($360,000) of the original estimate. Determine the contractor's gross profit for
each of the seven types of construction contracts for each of the following
conditions.

(a) U = 0, C = 0
(b) U = 0, C = 6% E = $360,000
(c) U = 4% E = $240,000, C = 0
(d) U = 4% E = $240,000 C = 6% E = $360,000
(e) U = -4% E = -$240,000, C = 0
(f) U = -4% E = -$240,000, C = 6% E = $360,000

In this example, the percentage markup for the cost plus fixed percentage contract
is 10% which is used as the bench mark for comparison. The percentage markup
for the lump sum contract is 12% while that for the unit price contract is 11%,
reflecting the degrees of higher risk. The fixed fee for the cost plus fixed fee is
based on 10% of the estimated cost, which is comparable to the cost plus fixed
percentage contract if there is no overestimate or underestimate in cost. The basic
percentage markup is 10% for both the cost plus variable percentage contract and
the target estimator contract, but they are subject to incentive bonuses and penalties
that are built in the formulas for owners' payments. The percentage markup for the
guaranteed maximum cost contract is 15% to account for the high risk undertaken
by the contractor. The results of computation for all seven types of contracts under
different conditions of underestimation U and change order C are shown in Table
8-4

TABLE 8-4 Contractor's Gross Profits under Different Conditions (in

$1,000)
U=0 U=0 U=4%E U=4%E U=-4%E U=-4%E
Type of Contract C=0 C=6%E C=0 C=6%E C=0 C=6%E
1. lump sum $720 $763 $480 $523 $960 $1,003
2. unit price 660 700 686 726 634 674
3. cost + fixed % 600 636 624 660 576 612
4. cost + fixed fee 600 600 600 600 600 600
5. cost + Var % 600 636 576 616 624 660
6. target estimate 600 600 480 480 720 720

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 7. guar. max. cost 900 540 660 300 1,140 780

Example 8-6: Owner's Payments under Different Contract Arrangements

Using the data in Example 8-5, determine the owner's actual payment for each of
the seven types of construction contracts for the same conditions of U and C. The
results of computation are shown in Table 8-5.

TABLE 8-5 Owner's Actual Payments under Different Conditions (in

$1,000)
U=0 U=0 U=4%E U=4%E U=-4%E U=-4%E
Type of Contract C=0 C=6%E C=0 C=6%E C=0 C=6%E
1. lump sum $6,720 $7,123 $6,720 $7,123 $6,720 $7,123
2. unit price 6,660 7,060 6,926 7,326 6,394 6,794
3. cost + fixed % 6,600 6,996 6,864 7,260 6,336 6,732
4. cost + fixed fee 6,600 6,960 6,840 7,200 6,360 6,720
5. cost + Var % 6,600 6,996 6,816 7,212 6,384 6,780
6. target estimate 6,600 6,960 6,720 7,080 6,480 6,840
7. guar. max. cost 6,900 6,900 6,900 6,900 6,900 6,900

Back to top

8.6 Principles of Competitive Bidding

Competitive bidding on construction projects involves decision making under
uncertainty where one of the greatest sources of the uncertainty for each bidder is
due to the unpredictable nature of his competitors. Each bid submitted for a
particular job by a contractor will be determined by a large number of factors,
including an estimate of the direct job cost, the general overhead, the confidence
that the management has in this estimate, and the immediate and long-range
objectives of management. So many factors are involved that it is impossible for a
particular bidder to attempt to predict exactly what the bids submitted by its
competitors will be.

It is useful to think of a bid as being made up of two basic elements: (1) the
estimate of direct job cost, which includes direct labor costs, material costs,
equipment costs, and direct filed supervision; and (2) the markup or return, which
must be sufficient to cover a portion of general overhead costs and allow a fair
profit on the investment. A large return can be assured simply by including a
sufficiently high markup. However, the higher the markup, the less chance there
will be of getting the job. Consequently a contractor who includes a very large
markup on every bid could become bankrupt from lack of business. Conversely, the
strategy of bidding with very little markup in order to obtain high volume is also

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likely to lead to bankruptcy. Somewhere in between the two extreme approaches to
bidding lies an "optimum markup" which considers both the return and the
likelihood of being low bidder in such a way that, over the long run, the average
return is maximized.

From all indications, most contractors confront uncertain bidding conditions by

exercising a high degree of subjective judgment, and each contractor may give
different weights to various factors. The decision on the bid price, if a bid is indeed
submitted, reflects the contractor's best judgment on how well the proposed project
fits into the overall strategy for the survival and growth of the company, as well as
the contractor's propensity to risk greater profit versus the chance of not getting a
contract.

One major concern in bidding competitions is the amount of "money left on the
table," of the difference between the winning and the next best bid. The winning
bidder would like the amount of "money left on the table" to be as small as
possible. For example, if a contractor wins with a bid of $200,000, and the next
lowest bid was $225,000 (representing $25,000 of "money left on the table"), then
the winning contractor would have preferred to have bid $220,000 (or perhaps
$224,999) to increase potential profits.

Some of the major factors impacting bidding competitions include:

Exogenous Economic Factors

Contractors generally tend to specialize in a submarket of construction and

concentrate their work in particular geographic locations. The level of demand in a
submarket at a particular time can influence the number of bidders and their bid
prices. When work is scarce in the submarket, the average number of bidders for
projects will be larger than at times of plenty. The net result of scarcity is likely to
be the increase in the number of bidders per project and downward pressure on the
bid price for each project in the submarket. At times of severe scarcity, some
contractors may cross the line between segments to expand their activities, or move
into new geographic locations to get a larger share of the existing submarket. Either
action will increase the risks incurred by such contractors as they move into less
familiar segments or territories. The trend of market demand in construction and of
the economy at large may also influence the bidding decisions of a contractor in
other ways. If a contractor perceives drastic increases in labor wages and material
prices as a result of recent labor contract settlements, it may take into consideration
possible increases in unit prices for determining the direct project cost.
Furthermore, the perceptions of increase in inflation rates and interest rates may
also cause the contractor to use a higher markup to hedge the uncertainty.
Consequently, at times of economic expansion and/or higher inflation rate,
contractors are reluctant to commit themselves to long-term fixed price contracts.

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Characteristics of Bidding Competition

All other things being equal, the probability of winning a contract diminishes as
more bidders participate in the competition. Consequently, a contractor tries to find
out as much information as possible about the number and identities of potential
bidders on a specific project. Such information is often available in the Dodge
Bulletin<Dodge Bulletin (daily publication), F. W. Dodge Corp., New York, NY.>
or similar publications which provide data of potential projects and names of
contractors who have taken out plans and specifications. For certain segments,
potential competitors may be identified through private contacts, and bidders often
confront the same competitor's project after project since they have similar
capabilities and interests in undertaking the same type of work, including size,
complexity and geographical location of the projects. A general contractor may also
obtain information of potential subcontractors from publications such as Credit
Reports(Credit Reports, Building Construction Division, and Bradstreet, Inc., New
York, N.Y.) published by Dun and Bradstreet, Inc. However, most contractors form
an extensive network with a group of subcontractors with whom they have had
previous business transactions. They usually rely on their own experience in
soliciting subcontract bids before finalizing a bid price for the project.

Objectives of General Contractors in Bidding

The bidding strategy of some contractors are influenced by a policy of minimum

percentage markup for general overhead and profit. However, the percentage
markup may also reflect additional factors stipulated by the owner such as high
retention and slow payments for completed work, or perceptions of uncontrollable
factors in the economy. The intensity of a contractor's efforts in bidding a specific
project is influenced by the contractor's desire to obtain additional work. The
winning of a particular project may be potentially important to the overall mix of
work in progress or the cash flow implications for the contractor. The contractor's
decision is also influenced by the availability of key personnel in the contractor
organization. The company sometimes wants to reserve its resources for future
projects, or commits itself to the current opportunity for different reasons.

Contractor's Comparative Advantages

A final important consideration in forming bid prices on the part of contractors are
the possible special advantages enjoyed by a particular firm. As a result of lower
costs, a particular contractor may be able to impose a higher profit markup yet still
have a lower total bid than competitors. These lower costs may result from superior
technology, greater experience, better management, better personnel or lower unit
costs. A comparative cost advantage is the most desirable of all circumstances in
entering a bid competition.

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284
8.7 Principles of Contract Negotiation
Negotiation is another important mechanism for arranging construction contracts.
Project managers often find themselves as participants in negotiations, either as
principal negotiators or as expert advisors. These negotiations can be complex and
often present important opportunities and risks for the various parties involved. For
example, negotiation on work contracts can involve issues such as completion date,
arbitration procedures, special work item compensation, contingency allowances as
well as the overall price. As a general rule, exogenous factors such as the history of
a contractor and the general economic climate in the construction industry will
determine the results of negotiations. However, the skill of a negotiator can affect
the possibility of reaching an agreement, the profitability of the project, the scope
of any eventual disputes, and the possibility for additional work among the
participants. Thus, negotiations are an important task for many project managers.
Even after a contract is awarded on the basis of competitive bidding, there are
many occasions in which subsequent negotiations are required as conditions change
over time.

In conducting negotiations between two parties, each side will have a series of
objectives and constraints. The overall objective of each party is to obtain the most
favorable, acceptable agreement. A two party, one issue negotiation illustrates this
fundamental point. Suppose that a developer is willing to pay up to $500,000 for a
particular plot of land, whereas the owner would be willing to sell the land for
$450,000 or more. These maximum and minimum sales prices
represent constraints on any eventual agreement. In this example, any purchase
price between $450,000 and $500,000 is acceptable to both of the involved parties.
This range represents a feasible agreement space. Successful negotiations would
conclude in a sales price within this range. Which party receives the $50,000 in the
middle range between $450,000 and $500,000 would typically depend upon the
negotiating skills and special knowledge of the parties involved. For example, if the
developer was a better negotiator, then the sales price would tend to be close to the
minimum $450,000 level.

With different constraints, it might be impossible to reach an agreement. For

example, if the owner was only willing to sell at a price of $550,000 while the
developer remains willing to pay only $500,000, then there would be no possibility
for an agreement between the two parties. Of course, the two parties typically do
not know at the beginning of negotiations if agreements will be possible. But it is
quite important for each party to the negotiation to have a sense of their
own reservation price, such as the owner's minimum selling price or the buyer's
maximum purchase price in the above example. This reservation price is equal to
the value of the best alternative to a negotiated agreement.

Poor negotiating strategies adopted by one or the other party may also preclude an
agreement even with the existence of a feasible agreement range. For example, one

285
party may be so demanding that the other party simply breaks off negotiations. In
effect, negotiations are not a well behaved solution methodology for the resolution
of disputes.

The possibility of negotiating failures in the land sale example highlights the
importance of negotiating style and strategy with respect to revealing information.
Style includes the extent to which negotiators are willing to seem reasonable, the
type of arguments chosen, the forcefulness of language used, etc. Clearly, different
negotiating styles can be more or less effective. Cultural factors are also extremely
important. American and Japanese negotiating styles differ considerably, for
example. Revealing information is also a negotiating decision. In the land sale case,
some negotiators would readily reveal their reserve or constraint prices, whereas
others would conceal as much information as possible (i.e. "play their cards close to
the vest") or provide misleading information.

In light of these tactical problems, it is often beneficial to all parties to adopt

objective standards in determining appropriate contract provisions. These standards
would prescribe a particular agreement or a method to arrive at appropriate values
in a negotiation. Objective standards can be derived from numerous sources,
including market values, precedent, professional standards, what a court would
decide, etc. By using objective criteria of this sort, personalities and disruptive
negotiating tactics do not become impediments to reaching mutually beneficial
agreements.

With additional issues, negotiations become more complex both in procedure and
in result. With respect to procedure, the sequence in which issues are defined or
considered can be very important. For example, negotiations may proceed on an
issue-by-issue basis, and the outcome may depend upon the exact sequence of
issues considered. Alternatively, the parties may proceed by proposing complete
agreement packages and then proceed to compare packages. With respect to
outcomes, the possibility of the parties having different valuations or weights on
particular issues arises. In this circumstance, it is possible to trade-off the outcomes
on different issues to the benefit of both parties. By yielding on an issue of low
value to himself but high value to the other party, concessions on other issues may
be obtained.

The notion of Pareto optimal agreements can be introduced to identify negotiated

agreements in which no change in the agreement can simultaneously make both
parties better off. Figure 8-1 illustrates Pareto optimal agreements which can be
helpful in assessing the result of multiple issue negotiations. In this figure, the axes
represent the satisfaction or desirability of agreements to the parties, denoted I and
II. This representation assumes that one can place a dollar or utility value on
various agreements reached in a multiple-issue negotiation between two parties.
Points in the graph represent particular agreements on the different issues under
consideration. A particular point may be obtained by more than one contract

286
agreement. The curved line encloses the set of all feasible agreements; any point in
this area is an acceptable agreement. Each party has a minimum acceptable
satisfaction level in this graph. Points on the interior of this feasible area
represent inferior agreements since some other agreement is possible that benefits
both parties. For example, point B represents a more desirable agreement than point
A. In the previous example, point B might represent a purchase price of $490,000
and an immediate purchase, whereas point A might represent a $475,000 sale price
and a six month delay. The feasible points that are not inferior constitute the set of
Pareto optimal or efficient agreements; these points lie on the north-east quadrant
of the feasible region as marked on the figure.

Figure 8-1 Illustration of a Pareto Optimal Agreement Set

The definition of Pareto optimal agreements allows one to assess at least one aspect
of negotiated outcomes. If two parties arrive at an inferior agreement (such as point
A in Figure 8-1), then the agreement could be improved to the benefit of both
parties. In contrast, different Pareto optimal agreements (such as points B and C in
Figure 8-1) can represent widely different results to the individual parties but do
not have the possibility for joint improvement.

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Of course, knowledge of the concept of Pareto optimal agreements does not
automatically give any guidance on what might constitute the best agreements.
Much of the skill in contract negotiation comes from the ability to invent new
options that represent mutual gains. For example, devising contract incentives for
speedier completion of projects may result in benefits to both contractors and the
owner.

Example 8-7: Effects of different value perceptions.

Suppose that the closing date for sale of the land in the previous case must also be
decided in negotiation. The current owner would like to delay the sale for six
months, which would represent rental savings of $10,000. However, the developer
estimates that the cost of a six month delay would be $20,000. After negotiation,
suppose that a purchase price of $475,000 and a six month purchase delay are
agreed upon. This agreement is acceptable but not optimal for both parties. In
particular, both sides would be better off if the purchase price was increased by
$15,000 and immediate closing instituted. The current owner would receive an
additional payment of $15,000, incur a cost of $10,000, and have a net gain of
$5,000. Similarly, the developer would pay $15,000 more for the land but save
$20,000 in delay costs. While this superior result may seem obvious and easily
achievable, recognizing such opportunities during a negotiation becomes
increasingly difficult as the number and complexity of issues increases.
Back to top

8.8 Negotiation Simulation: An Example

This construction negotiation game simulates a contract negotiation between a
utility, "CMG Gas" and a design/construct firm, "Pipeline Constructors,
Inc." [4] The negotiation involves only two parties but multiple issues. Participants
in the game are assigned to represent one party or the other and to negotiate with a
designated partner. In a class setting, numerous negotiating partners are created.
The following overview from the CMG Gas participants' instructions describes the
setting for the game:

CMG Gas has the opportunity to provide natural gas to an automobile factory under
construction. Service will require a new sixteen mile pipeline through farms and
light forest. The terrain is hilly with moderate slopes, and equipment access is
relatively good. The pipeline is to be buried three feet deep. Construction of the
pipeline itself will be contracted to a qualified design/construction firm, while
required compression stations and ancillary work will be done by CMG Gas. As
project manager for CMG Gas, you are about to enter negotiations with a local
contractor, "Pipeline Constructors, Inc." This firm is the only local contractor
qualified to handle such a large project. If a suitable contract agreement cannot be
reached, then you will have to break off negotiations soon and turn to another
company.

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The Pipeline Constructors, Inc. instructions offers a similar overview.

To focus the negotiations, the issues to be decided in the contract are already
defined:

• Duration
The final contract must specify a required completion date.
• Penalty for Late Completion
The final contract may include a daily penalty for late project completion on
the part of the contractor.
• Bonus for Early Completion
The final contract may include a daily bonus for early project completion.
• Report Format
Contractor progress reports will either conform to the traditional CMG Gas
format or to a new format proposed by the state.
• Frequency of Progress Reports
Progress reports can be required daily, weekly, bi-weekly or monthly.
• Conform to Pending Legislation Regarding Pipeline Marking
State legislation is pending to require special markings and drawings for
pipelines. The parties have to decide whether to conform to this pending
legislation.
• Contract Type
The construction contract may be a flat fee, a cost plus a percentage profit, or
a guaranteed maximum with cost plus a percentage profit below the
maximum.
• Amount of Flat Fee
If the contract is a flat fee, the dollar amount must be specified.
• Percentage of Profit
If the contract involves a percentage profit, then the percentage must be
agreed upon.
• CMG Gas Clerk on Site
The contract may specify that a CMG Gas Clerk may be on site and have
access to all accounts or that only progress reports are made by Pipeline
Constructors, Inc.
• Penalty for Late Starting Date
CMG Gas is responsible for obtaining right-of-way agreements for the new
pipeline. The parties may agree to a daily penalty if CMG Gas cannot obtain
these agreements.

A final contract requires an agreement on each of these issues, represented on a

form signed by both negotiators.

As a further aid, each participant is provided with additional information and a

scoring system to indicate the relative desirability of different contract agreements.
Additional information includes items such as estimated construction cost and

289
expected duration as well as company policies such as desired reporting formats or
work arrangements. This information may be revealed or withheld from the other
party depending upon an individual's negotiating strategy. The numerical scoring
system includes point totals for different agreements on specific issues, including
interactions among the various issues. For example, the amount of points received
by Pipeline Constructors, Inc. for a bonus for early completion increases as the
completion date become later. An earlier completion becomes more likely with a
later completion date, and hence the probability of receiving a bonus increases, so
the resulting point total likewise increases.

The two firms have differing perceptions of the desirability of different agreements.
In some cases, their views will be directly conflicting. For example, increases in a
flat fee imply greater profits for Pipeline Constructors, Inc. and greater costs for
CMG Gas. In some cases, one party may feel strongly about a particular issue,
whereas the other is not particularly concerned. For example, CMG Gas may want
a clerk on site, while Pipeline Constructors, Inc. may not care. As described in the
previous section, these differences in the evaluation of an issue provide
opportunities for negotiators. By conceding an unimportant issue to the other party,
a negotiator may trade for progress on an issue that is more important to his or her
firm. Examples of instructions to the negotiators appear below.

Instructions to the Pipelines Constructors, Inc. Representative

After examining the project site, your company's estimators are convinced that the
project can be completed in thirty-six weeks. In bargaining for the duration, keep
two things in mind; the longer past thirty-six weeks the contract duration is, the
more money that can be made off the "bonuses for being early" and the chances of
being late are reduced. That reduces the risk of paying a "penalty for lateness".

Throughout the project the gas company will want progress reports. These reports
take time to compile and therefore the fewer you need to submit, the better. In
addition, State law dictates that the Required Standard Report be used unless the
contractor and the owner agree otherwise. These standard reports are even more
time consuming to produce than more traditional reports.

The State Legislature is considering a law that requires accurate drawings and
markers of all pipelines by all utilities. You would prefer not to conform to this
uncertain set of requirements, but this is negotiable.

What type of contract and the amount your company will be paid are two of the
most important issues in negotiations. In the Flat Fee contract, your company will
receive an agreed amount from CMG Gas. Therefore, when there are any delay or
cost overruns, it will be the full responsibility of your company. with this type of
contract, your company assumes all the risk and will in turn want a higher price.

290
Your estimators believe a cost and contingency amount of 4,500,000 dollars. You
would like a higher fee, of course.

With the Cost Plus Contract, the risk is shared by the gas company and your
company. With this type of contract, your company will bill CMG Gas for all of its
costs, plus a specified percentage of those costs. In this case, cost overruns will be
paid by the gas company. Not only does the percentage above cost have to be
decided upon but also whether or not your company will allow a Field Clerk from
the gas company to be at the job site to monitor reported costs. Whether or not he is
around is of no concern to your company since its policy is not to inflate costs. this
point can be used as a bargaining weapon.

Finally, your company is worried whether the gas company will obtain the land
rights to lay the pipe. Therefore, you should demand a penalty for the potential
delay of the project starting date.

Instructions to the CMG Gas Company Representative

In order to satisfy the auto manufacturer, the pipeline must be completed in forty
weeks. An earlier completion date will not result in receiving revenue any earlier.
Thus, the only reason to bargain for shorter duration is to feel safer about having
the project done on time. If the project does exceed the forty week maximum, a
penalty will have to be paid to the auto manufacturer. Consequently, if the project
exceeds the agreed upon duration, the contractor should pay you a penalty. The
penalty for late completion might be related to the project duration. For example, if
the duration is agreed to be thirty-six weeks, then the penalty for being late need
not be so severe. Also, it is normal that the contractor get a bonus for early
completion. Of course, completion before forty weeks doesn't yield any benefit
other than your own peace of mind. Try to keep the early bonus as low as possible.

Throughout the project you will want progress reports. The more often these
reports are received, the better to monitor the progress. State law dictates that the
Required Standard Report be used unless the contractor and the owner agree
otherwise. These reports are very detailed and time consuming to review. You
would prefer to use the traditional CMG Gas reports.

The state legislature is considering a law that requires accurate drawings and
markers of all pipelines by all utilities. For this project it will cost an additional
$250,000 to do this now, or $750,000 to do this when the law is passed.

One of the most important issues is the type of contract, and the amount of be paid.
The Flat Fee contract means that CMG Gas will pay the contractor a set amount.
Therefore, when there are delays and cost overruns, the contractor assumes full
responsibility for the individual costs. However, this evasion of risk has to be paid
for and results in a higher price. If Flat Fee is chosen, only the contract price is to

291
be determined. Your company's estimators have determined that the project should
cost about $5,000,000.

The Cost Plus Percent contract may be cheaper, but the risk is shared. With this
type of contract, the contractor will bill the gas company for all costs, plus a
specified percentage of those costs. In this case, cost overruns will be paid by the
gas company. If this type of contract is chosen, not only must the profit percentage
be chosen, but also whether or not a gas company representative will be allowed on
site all of the time acting as a Field Clerk, to ensure that a proper amount of
material and labor is billed. The usual percentage agreed upon is about ten percent.

Contractors also have a concern whether or not they will receive a penalty if the gas
right-of-way is not obtained in time to start the project. In this case, CMG Gas has
already secured the right-of-ways. But, if the penalty is too high, this is a dangerous
precedent for future negotiations. However, you might try to use this as a
bargaining tool.

Example 8-8: An example of a negotiated contract

A typical contract resulting from a simulation of the negotiation between CMG Gas
and Pipeline Constructors, Inc. appears in Table 8-6. An agreement with respect to
each pre-defined issue is included, and the resulting contract signed by both
negotiators.
TABLE 8-6 Example of a Negotiated Contract between CMG Gas and
Pipeline Constructors, Inc
Duration 38 weeks
Penalty for Late Completion $6,800 per day
Bonus for Early Completion $0 per day
Report Format traditional CMG form
Frequency of Progress Reports weekly
Conform to Pending Pipeline Marking Legislation yes
Contract Type flat fee
Amount of Flat Fee $5,050,000
Percentage of Profit Not applicable
CMG Gas Clerk on Site yes
Penalty for Late Starting Date $3,000 per day
Signed:

CMG Gas Representative

Pipeline Constructors, Inc.

Example 8-9: Scoring systems for the negotiated contract games

292
To measure the performance of the negotiators in the previous example, a scoring
system is needed for the representative of Pipeline Constructors, Inc. and another
scoring system for the representative of CMG Gas. These scoring systems for the
companies associated with the issues described in Example 8-7 are designated as
system A.

In order to make the negotiating game viable for classroom use, another set of
instructions for each company is described in this example, and the associated
scoring systems for the two companies are designated as System B. In each game
play, the instructor may choose a different combination of instructions and
negotiating teams, leading to four possible combinations of scoring systems for
Pipeline Constructors, Inc. and CMG Gas. [5]

Instruction To The Pipeline Constructors, Inc. Representative

In order to help you, your boss has left you with a scoring table for all the issues
and alternatives. Two different scoring systems are listed here; you will be assigned
to use one or the other. Instructions for scoring system A are included in Section
8.9. The instructions for scoring system B are as follows:

After examining the site, your estimator believes that the project will require 38
weeks. You are happy to conform with any reporting or pipeline marking system,
since your computer based project control and design systems can easily produce
these submissions. You would prefer to delay the start of the contract as long as
possible, since your forces are busy on another job; hence, you do not want to
impose a penalty for late start. Try to maximize the amount of points, as they
reflect profit brought into your company, or a cost savings. In Parts 3 and 4, be sure
to use the project duration agreed upon to calculate your score. Finally, do not
discuss your scoring system with the CMG Gas representative; this is proprietary
information!

SCORING FOR PIPELINE CONSTRUCTORS, INC.

NOTE: NA means not acceptable and the deal will not be approved by your boss
with any of these provisions. also, the alternatives listed are the only ones in the
context of this problem; no other alternatives are acceptable.

1. COMPLETION DATE
System A System B
Under 36 Weeks NA NA
36 weeks 0 NA
37 weeks +5 -10
38 weeks +10 0
39 weeks +20 +10
40 weeks +40 +20

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2. REPORTS
State Standard Report -20 0
CMG Reports -5 0

3. PENALTY FOR LATENESS ($ PER DAY)

DURATION (WEEKS)
Scoring System A 36 37 38 39 40
Scoring System B 37 38 39 40 41
0 - 999 -1 -1 -1 0 0
1,000 - 1,999 -2 -2 -2 -1 0
2,000 - 2,999 -4 -3 -3 -2 -1
3,000 - 3,999 -6 -5 -4 -3 -1
4,000 - 4,999 -8 -7 -5 -4 -2
5,000 - 5,999 -11 -9 -7 -5 -2
6,000 - 6,999 -14 -12 -9 -6 -3
7,000 - 7,999 -18 -14 -11 -7 -3
Over 8,000 NA NA NA NA NA

4. BONUS FOR BEING EARLY ($ PER DAY)

Scoring System A 36 37 38 39 40
Scoring System B 37 38 39 40 41
0 - 999 0 0 0 0 2
1,000 - 1,999 0 0 2 2 2
2,000 - 2,999 0 2 4 4 4
3,000 - 3,999 1 4 6 6 8
4,000 - 4,999 2 6 8 10 12
5,000 - 5,999 3 8 10 14 16
6,000 - 6,999 4 10 14 18 22
7,000 - 7,999 5 12 18 24 28
8,000 - 8,999 6 14 22 28 36
9,000 - 9,999 7 16 26 32 40
Over 10,000 8 18 30 36 45

5. CONFORM TO PENDING LEGISLATION (MARKING PIPELINES)

A B
Yes +5 +10
No +15 +10

6. HOW OFTEN FOR THE PROGRESS REPORTS

A B
Daily NA 0
Weekly -20 0
Bi-weekly -10 0
Monthly -6 0

7. CONTRACT TYPE
A B
Flat Fee 5 5
Cost + X% +25 +25

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If Flat Fee do part 8 and skip parts 9 and 10.
If Cost + X% do parts 9 and 10 and skip part 8.

8. FLAT FEE ($)

A B
Below 4,500,000 NA -15 for each 10,000
Over 4,500,000 +1 for each 10,000 +2 for each 10,000

9. IF COST PLUS X%
A B
Below 6% NA NA
6% +250 NA
7% +375 +300
8% +450 +330
9% +475 +360
10% +500 +400
11% +525 +440
12% +550 +480
13% +600 +540
14% +725 +600
Over 14% +900 +800

10. GAS CO. FIELD CLERK ON SITE

A B
Yes 0 0
No 0 +10

11. PENALTY FOR DELAYED STARTING DATE DUE TO GAS COMPANY ERROR ($
PER DAY)
A B
0 - 499 NA NA
500 - 1499 -6 -10
1500 - 2499 -4 -7
1500 - 3499 -2 -5
3500 - 4499 -1 -3
4500 - 5499 0 -1
5500 - 6499 +1 0
6500 - 7499 +2 +3
7500 or more +4 +6

Instructions to the CMG Gas Company Representative

In order to help you, your boss has left you with a scoring table for all the issues
and alternatives. Two different scoring systems are listed here; you will be assigned
to use one or the other. Instructions for scoring system A are included in Section
8.9. The instructions for scoring system B are described as follows:

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Your contract with the automobile company provides an incentive for completion
of the pipeline earlier than 38 weeks and a penalty for completion after 38 weeks.
To insure timely completion of the project, you would like to receive detailed
project reports as often as possible.

Try to maximize the number of points from the final contract provisions; this
corresponds to minimizing costs. Do not discuss your scoring systems with
Pipeline Constructors, Inc.

SCORING SYSTEM FOR CMG GAS

NOTE: NA means not acceptable and the deal will not be approved by your boss
with any of these provisions. If you can't negotiate a contract, your score will be
+450. Also, the alternatives listed are the only ones in the context of this problem
no other alternatives are acceptable.

1. DURATION POINTS
System A System B
Over 40 weeks NA -40
40 weeks 0 -10
39 weeks +2 +2
38 weeks +4 +8
37 weeks +5 +14
0-36 weeks +6 +14

2. REPORTS A B
Required Standard Report
+2 0
"Traditional" CMG Gas
+10 0
Reports

3. PENALTY FOR LATENESS ($ PER DAY)

DURATION (WEEKS)
Scoring System A 36 37 38 39 40
Scoring System B 38 39 40 41 42
0 - 999 NA NA NA NA NA
1,000 - 1,999 9 7 6 3 0
2,000 - 2,999 10 9 8 5 2
3,000 - 3,999 11 10 9 6 4
4,000 - 4,999 12 11 10 7 5
5,000 - 5,999 13 12 11 8 6
6,000 - 6,999 14 13 12 9 7
7,000 - 7,999 15 15 13 11 8
8,000 - 8,999 16 15 14 12 9
9,000 - 9,999 17 16 15 13 10
10,000 or more 18 16 15 13 11

4. BONUS FOR BEING EARLY ($ PER DAY)

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 A B
8000 or more NA -5
7000 - 7999 +3 -2
6000 - 6999 +6 -1
5000 - 5999 +8 0
4000 - 4999 +10 +5
3000 - 3999 +12 +7
2000 - 2999 +13 +9
1000 - 1999 +14 +13
0 - 999 +15 +17

5. CONFORM TO PENDING LEGISLATION (MARKING PIPELINES)

A B
Yes +25 0
No -25 NA

6. HOW OFTEN FOR THE PROGRESS REPORTS

A B
Daily +45 +50
Weekly +50 +30
Bi-weekly +30 +10
Monthly NA +5

7. CONTRACT TYPE
A B
Flat Fee 25 25
Cost + X% 0 0
If Flat Fee do part 8 and skip parts 9 and 10.
If Cost + X% do parts 9 and 10 and skip part 8.

8. FLAT FEE ($)

A B
Over 5,000,000 NA NA
0 - 5,000,000 +1 for each +1 for each
10,000 10,000
below below
5,000,000 5,000,000

9. IF COST PLUS X%
A B
Below 5% +950 +700
5% +800 +660
6% +700 +620
7% +600 +590
8% +550 +570
9% +525 +550
10% +500 +535
11% +475 +500
12% +450 +440

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13% +400 +380
14% +300 +300
15% +200 +100
Over 14% NA +10

10. GAS CO. FIELD CLERK ON SITE

A B
Yes +20 +10
No +5 0

11. PENALTY FOR DELAYED STARTING DATE DUE TO UNAVAILABLE RIGHT-OF-

WAYS ($ PER DAY)
A B
0 - 1,999 +10 +3
2,000 - 3,999 +8 +2
4,000 - 5,999 +6 +1
6,000 - 7,999 +4 0
8,000 - 9,999 +2 -10
10,000 or more NA -20

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8.9 Resolution of Contract Disputes

Once a contract is reached, a variety of problems may emerge during the course of
work. Disputes may arise over quality of work, over responsibility for delays, over
appropriate payments due to changed conditions, or a multitude of other
considerations. Resolution of contract disputes is an important task for project
managers. The mechanism for contract dispute resolution can be specified in the
original contract or, less desireably, decided when a dispute arises.

The most prominent mechanism for dispute resolution is adjudication in a court of

law. This process tends to be expensive and time consuming since it involves legal
representation and waiting in queues of cases for available court times. Any party
to a contract can bring a suit. In adjudication, the dispute is decided by a neutral,
third party with no necessary specialized expertise in the disputed subject. After all,
it is not a prerequisite for judges to be familiar with construction procedures! Legal
procedures are highly structured with rigid, formal rules for presentations and fact
finding. On the positive side, legal adjudication strives for consistency and
predictability of results. The results of previous cases are published and can be used
as precedents for resolution of new disputes.

Negotiation among the contract parties is a second important dispute resolution

mechanism. These negotiations can involve the same sorts of concerns and issues
as with the original contracts. Negotiation typically does not involve third parties

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such as judges. The negotiation process is usually informal, unstructured and
relatively inexpensive. If an agreement is not reached between the parties, then
adjudication is a possible remedy.

A third dispute resolution mechanism is the resort to arbitration or mediation and

conciliation. In these procedures, a third party serves a central role in the resolution.
These outside parties are usually chosen by mutually agreement of the parties
involved and will have specialized knowledge of the dispute subject. In arbitration,
the third party may make a decision which is binding on the participants. In
mediation and conciliation, the third party serves only as a facilitator to help the
participants reach a mutually acceptable resolution. Like negotiation, these
procedures can be informal and unstructured.

Finally, the high cost of adjudication has inspired a series of non-traditional dispute
resolution mechanisms that have some of the characteristics of judicial
proceedings. These mechanisms include:

• Private judging in which the participants hire a third party judge to make a
decision,
• Neutral expert fact-finding in which a third party with specialized
knowledge makes a recommendation, and
• Mini-trial in which legal summaries of the participants' positions are
presented to a jury comprised of principals of the affected parties.

Some of these procedures may be court sponsored or required for particular types
of disputes.

While these various disputes resolution mechanisms involve varying costs, it is

important to note that the most important mechanism for reducing costs and
problems in dispute resolution is the reasonableness of the initial contract among
the parties as well as the competence of the project manager.

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8.10 References
1. Au, T., R.L. Bostleman and E.W. Parti, "Construction Management Game-
Deterministic Model," Asce Journal of the Construction Division, Vol. 95,
1969, pp. 25-38.
2. Building Research Advisory Board, Exploratory Study on Responsibility,
Liability and Accountability for Risks in Construction, National Academy of
Sciences, Washington, D.C., 1978.
3. Construction Industry Cost Effectiveness Project, "Contractual
Arrangements," Report A-7, The Business Roundtable, New York, October
1982.

299
 4. Dudziak, W. and C. Hendrickson, "A Negotiating Simulation Game," ASCE
Journal of Management in Engineering, Vol. 4, No. 2, 1988.
5. Graham, P.H., "Owner Management of Risk in Construction
Contracts," Current Practice in Cost Estimating and Cost
Control, Proceedings of an ASCE Conference, Austin, Texas, April 1983,
pp. 207-215.
6. Green, E.D., "Getting Out of Court -- Private Resolution of Civil
Disputes," Boston Bar Journal, May-June 1986, pp. 11-20.
7. Park, William R., The Strategy of Contracting for Profit, 2nd Edition,
Prentice-Hall, Englewood Cliffs, NJ, 1986.
8. Raiffa, Howard, The Art and Science of Negotiation, Harvard University
Press, Cambridge, MA, 1982.
9. Walker, N., E.N. Walker and T.K. Rohdenburg, Legal Pitfalls in
Architecture, Engineering and Building Construction, 2nd Edition,
McGraw-Hill Book Co., New York, 1979.

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8.11 Problems
1. Suppose that in Example 8-5, the terms for the guaranteed maximum cost
contract are such that change orders will not be compensated if their total
cost is within 3% of the original estimate, but will be compensated in full for
the amount beyond 3% of the original estimate. If all other conditions remain
unchanged, determine the contractor's profit and the owner's actual payment
under this contract for the following conditions of U and C:
1. U = 0, C = 6%E
2. U = 4%E, C = 6%E
C = 6%E
3. U = - 4%E,
2. Suppose that in Example 8-5, the terms of the target estimate contract call
for N = 0.3 instead of N = 0.5, meaning that the contractor will receive 30%
of the savings. If all other conditions remain unchanged, determine the
contractor's profit and the owner's actual payment under this contract for the
given conditions of U and C.

3. Suppose that in Example 8-5, the terms of the cost plus variable percentage
contract allow an incentive bonus for early completion and a penalty for late
completion of the project. Let D be the number of days early, with negative
value denoting D days late. The bonus per days early or the penalty per day
late with be T dollars. The agreed formula for owner's payment is:

P = R(2E - A + C) + A + C + DT(1 + 0.4C/E)

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 The value of T is set at $5,000 per day, and the project is completed 30 days
behind schedule. If all other conditions remain unchanged, find the
contractor's profit and the owner's actual payment under this contract for the
given conditions of U and C.

4. Consider a construction project for which the contractor's estimate is

$3,000,000. For various types of contracts, R = 10%, R1 = 3%, R2 = 1.5%,
R3 = 6% and N = 0.6. The contractor is not compensated for change orders
under the guaranteed maximum cost contract if the total cost for the change
order is within 5% ($150,000) of the original estimate. Determine the
contractor's gross profit for each of the seven types of construction contracts
for each of the following conditions of U and C:
1. U = 0, C = 0
2. U = 0, C = 4% E = $120,000
3. U = 5% E = $150,000, C = 0
4. U = 5% E = $150,000, C = 4% E = 120,000
5. U = 2% E = $60,000, C = 0
C = 4% E = 120,000
6. U = 2% E = $60,000,
5. Using the data in Problem 4, determine the owner's actual payment for each
of the seven types of construction contracts for the same conditions of U and
C.

6. Suppose that in Problem 4, the terms of the guaranteed maximum cost

contract are such that change orders will not be compensated if their total
cost is within 3% of the original estimate, but will be compensated in full for
the amount beyond 3% of the original estimate. If all conditions remained
unchanged, determine the contractor's profit and the owner's actual payment
under this contract for the following conditions of U and C:
1. U = 0, C = 5%E
2. U = 2%, C = 5%E
C = 5%E
3. U = -2%,
7. Suppose that in Problem 4, the terms of the target estimate contract call for
N = 0.7 instead of N = 0.3, meaning that the contractor will receive 70% of
the savings. If all other conditions remain unchanged, determine the
contractor's profit and the owner's actual payment under this contract for the
given conditions of U and C.

8. Suppose that in Problem 4, the terms of the cost plus variable percentage
contract allow an incentive bonus for early completion and a penalty for late
completion of the project. Let D be the number of days early, with negative

301
 value denoting D days late. The bonus per days early or the penalty per day
late will be T dollars. The agreed formula for owner's payment is:

P = R(2E - A + C) + A + C + DT(1 + 0.2C/E)

The value of T is set at $ 10,000 per day, and the project is completed 20
days ahead schedule. If all other conditions remain unchanged, find the
contractor's profit and the owner's actual payment under this contract for the
given conditions of U and C.

9. In playing the construction negotiating game described in Section 8.8, your

instructor may choose one of the following combinations of companies and
issues leading to different combinations of the scoring systems:
Pipeline Constructors Inc. CMG Gas
a. System A System A
b. System A System B
c. System B System A
d. System B System B
10. Since the scoring systems are confidential information, your instructor will
not disclose the combination used for the assignment. Your instructor may
divide the class into groups of two students, each group acting as negotiators
representing the two companies in the game. To keep the game interesting
and fair, do not try to find out the scoring system of your negotiating
counterpart. To seek insider information is unethical and illegal!

Back to top

8.12 Footnotes
1. These examples are taken directly from A Construction Industry Cost
Effectiveness Project Report, "Contractual Arrangements," The Business
Roundtable, New York, Appendix D, 1982. Permission to quote this material from
the Business Roundtable is gratefully acknowledged. Back

2. See C.D. Sutliff and J.G. Zack, Jr. "Contract Provisions that Ensure Complete
Cost Disclosures", Cost Engineering, Vol. 29, No. 10, October 1987, pp. 10-
14. Back

3. Arkansas Rice Growers v. Alchemy Industries, Inc., United States Court of

Appeals, Eighth Circuit, 1986. The court decision appears in 797 Federal Reporter,
2d Series, pp. 565-574. Back

4. This game is further described in W. Dudziak and C. Hendrickson, "A

Negotiation Simulation Game," ASCE Journal of Management in Engineering,
Vol. 4, No. 2, 1988. Back

302
5. To undertake this exercise, the instructor needs to divide students into
negotiating teams, with each individual assigned scoring system A or B.
Negotiators will represent Pipeline Constructors, Inc. or CMG Gas. Negotiating
pairs should not be told which scoring system their counterpart is assigned. Back

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9. Construction Planning
9.1 Basic Concepts in the Development of Construction
Plans
Construction planning is a fundamental and challenging activity in the
management and execution of construction projects. It involves the choice of
technology, the definition of work tasks, the estimation of the required resources
and durations for individual tasks, and the identification of any interactions among
the different work tasks. A good construction plan is the basis for developing the
budget and the schedule for work. Developing the construction plan is a critical
task in the management of construction, even if the plan is not written or otherwise
formally recorded. In addition to these technical aspects of construction planning, it
may also be necessary to make organizational decisions about the relationships
between project participants and even which organizations to include in a project.
For example, the extent to which sub-contractors will be used on a project is often
determined during construction planning.

Forming a construction plan is a highly challenging task. As Sherlock Holmes

noted:

Most people, if you describe a train of events to them, will tell you what the result
would be. They can put those events together in their minds, and argue from them
that something will come to pass. There are few people, however, who, if you told
them a result, would be able to evolve from their own inner consciousness what the
steps were which led up to that result. This power is what I mean when I talk of
reasoning backward. [1]

Like a detective, a planner begins with a result (i.e. a facility design) and must
synthesize the steps required to yield this result. Essential aspects of construction
planning include the generation of required activities, analysisof the implications
of these activities, and choice among the various alternative means of performing
activities. In contrast to a detective discovering a single train of events, however,
construction planners also face the normative problem of choosing the best among
numerous alternative plans. Moreover, a detective is faced with an observable
result, whereas a planner must imagine the final facility as described in the plans
and specifications.

In developing a construction plan, it is common to adopt a primary emphasis on

either cost control or on schedule control as illustrated in Fig. 9-1. Some projects
are primarily divided into expense categories with associated costs. In these cases,
construction planning is cost or expense oriented. Within the categories of
expenditure, a distinction is made between costs incurred directly in the

304
performance of an activity and indirectly for the accomplishment of the project. For
example, borrowing expenses for project financing and overhead items are
commonly treated as indirect costs. For other projects, scheduling of work activities
over time is critical and is emphasized in the planning process. In this case, the
planner insures that the proper precedences among activities are maintained and
that efficient scheduling of the available resources prevails. Traditional scheduling
procedures emphasize the maintenance of task precedences (resulting in critical
path scheduling procedures) or efficient use of resources over time (resulting in job
shop scheduling procedures). Finally, most complex projects require consideration
of both cost and scheduling over time, so that planning, monitoring and record
keeping must consider both dimensions. In these cases, the integration of schedule
and budget information is a major concern.

Figure 9-1 Alternative Emphases in Construction Planning

In this chapter, we shall consider the functional requirements for construction

planning such as technology choice, work breakdown, and budgeting. Construction
planning is not an activity which is restricted to the period after the award of a
contract for construction. It should be an essential activity during the facility
design. Also, if problems arise during construction, re-planning is required.

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305
9.2 Choice of Technology and Construction Method
As in the development of appropriate alternatives for facility design, choices of
appropriate technology and methods for construction are often ill-structured yet
critical ingredients in the success of the project. For example, a decision whether to
pump or to transport concrete in buckets will directly affect the cost and duration of
tasks involved in building construction. A decision between these two alternatives
should consider the relative costs, reliabilities, and availability of equipment for the
two transport methods. Unfortunately, the exact implications of different methods
depend upon numerous considerations for which information may be sketchy
during the planning phase, such as the experience and expertise of workers or the
particular underground condition at a site.

In selecting among alternative methods and technologies, it may be necessary to

formulate a number of construction plans based on alternative methods or
assumptions. Once the full plan is available, then the cost, time and reliability
impacts of the alternative approaches can be reviewed. This examination of several
alternatives is often made explicit in bidding competitions in which several
alternative designs may be proposed or value engineering for alternative
construction methods may be permitted. In this case, potential constructors may
wish to prepare plans for each alternative design using the suggested construction
method as well as to prepare plans for alternative construction methods which
would be proposed as part of the value engineering process.

In forming a construction plan, a useful approach is to simulate the construction

process either in the imagination of the planner or with a formal computer based
simulation technique. [2] By observing the result, comparisons among different
plans or problems with the existing plan can be identified. For example, a decision
to use a particular piece of equipment for an operation immediately leads to the
question of whether or not there is sufficient access space for the equipment. Three
dimensional geometric models in a computer aided design (CAD) system may be
helpful in simulating space requirements for operations and for identifying any
interferences. Similarly, problems in resource availability identified during the
simulation of the construction process might be effectively forestalled by providing
additional resources as part of the construction plan.

Example 9-1: A roadway rehabilitation

An example from a roadway rehabilitation project in Pittsburgh, PA can serve to

illustrate the importance of good construction planning and the effect of technology
choice. In this project, the decks on overpass bridges as well as the pavement on the
highway itself were to be replaced. The initial construction plan was to work
outward from each end of the overpass bridges while the highway surface was
replaced below the bridges. As a result, access of equipment and concrete trucks to
the overpass bridges was a considerable problem. However, the highway work

306
could be staged so that each overpass bridge was accessible from below at
prescribed times. By pumping concrete up to the overpass bridge deck from the
highway below, costs were reduced and the work was accomplished much more
quickly.

Example 9-2: Laser Leveling

An example of technology choice is the use of laser leveling equipment to improve

the productivity of excavation and grading. [3] In these systems, laser surveying
equipment is erected on a site so that the relative height of mobile equipment is
known exactly. This height measurement is accomplished by flashing a rotating
laser light on a level plane across the construction site and observing exactly where
the light shines on receptors on mobile equipment such as graders. Since laser light
does not disperse appreciably, the height at which the laser shines anywhere on the
construction site gives an accurate indication of the height of a receptor on a piece
of mobile equipment. In turn, the receptor height can be used to measure the height
of a blade, excavator bucket or other piece of equipment. Combined with electro-
hydraulic control systems mounted on mobile equipment such as bulldozers,
graders and scrapers, the height of excavation and grading blades can be precisely
and automatically controlled in these systems. This automation of blade heights has
reduced costs in some cases by over 80% and improved quality in the finished
product, as measured by the desired amount of excavation or the extent to which a
final grade achieves the desired angle. These systems also permit the use of smaller
machines and less skilled operators. However, the use of these semi-automated
systems require investments in the laser surveying equipment as well as
modification to equipment to permit electronic feedback control units. Still, laser
leveling appears to be an excellent technological choice in many instances.
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9.3 Defining Work Tasks

At the same time that the choice of technology and general method are considered,
a parallel step in the planning process is to define the various work tasks that must
be accomplished. These work tasks represent the necessary framework to
permit scheduling of construction activities, along with estimating
the resources required by the individual work tasks, and any
necessary precedences or required sequence among the tasks. The terms work
"tasks" or "activities" are often used interchangeably in construction plans to refer
to specific, defined items of work. In job shop or manufacturing terminology, a
project would be called a "job" and an activity called an "operation", but the sense
of the terms is equivalent. [4] The scheduling problem is to determine an
appropriate set of activity start time, resource allocations and completion times that
will result in completion of the project in a timely and efficient fashion.
Construction planning is the necessary fore-runner to scheduling. In this planning,

307
defining work tasks, technology and construction method is typically done either
simultaeously or in a series of iterations.

The definition of appropriate work tasks can be a laborious and tedious process, yet
it represents the necessary information for application of formal scheduling
procedures. Since construction projects can involve thousands of individual work
tasks, this definition phase can also be expensive and time consuming. Fortunately,
many tasks may be repeated in different parts of the facility or past facility
construction plans can be used as general models for new projects. For example,
the tasks involved in the construction of a building floor may be repeated with only
minor differences for each of the floors in the building. Also, standard definitions
and nomenclatures for most tasks exist. As a result, the individual planner defining
work tasks does not have to approach each facet of the project entirely from
scratch.

While repetition of activities in different locations or reproduction of activities

from past projects reduces the work involved, there are very few computer aids for
the process of defining activities. Databases and information systems can assist in
the storage and recall of the activities associated with past projects as described in
Chapter 14. For the scheduling process itself, numerous computer programs are
available. But for the important task of defining activities, reliance on the skill,
judgment and experience of the construction planner is likely to continue.

More formally, an activity is any subdivision of project tasks. The set of activities
defined for a project should be comprehensive or completely exhaustive so that all
necessary work tasks are included in one or more activities. Typically, each design
element in the planned facility will have one or more associated project activities.
Execution of an activity requires time and resources, including manpower and
equipment, as described in the next section. The time required to perform an
activity is called the duration of the activity. The beginning and the end of
activities are signposts or milestones, indicating the progress of the project.
Occasionally, it is useful to define activities which have no duration to mark
important events. For example, receipt of equipment on the construction site may
be defined as an activity since other activities would depend upon the equipment
availability and the project manager might appreciate formal notice of the arrival.
Similarly, receipt of regulatory approvals would also be specially marked in the
project plan.

The extent of work involved in any one activity can vary tremendously in
construction project plans. Indeed, it is common to begin with fairly coarse
definitions of activities and then to further sub-divide tasks as the plan becomes
better defined. As a result, the definition of activities evolves during the preparation
of the plan. A result of this process is a natural hierarchy of activities with large,
abstract functional activities repeatedly sub-divided into more and more specific
sub-tasks. For example, the problem of placing concrete on site would have sub-

308
activities associated with placing forms, installing reinforcing steel, pouring
concrete, finishing the concrete, removing forms and others. Even more
specifically, sub-tasks such as removal and cleaning of forms after concrete
placement can be defined. Even further, the sub-task "clean concrete forms" could
be subdivided into the various operations:

• Transport forms from on-site storage and unload onto the cleaning station.
• Position forms on the cleaning station.
• Wash forms with water.
• Clean concrete debris from the form's surface.
• Coat the form surface with an oil release agent for the next use.
• Unload the form from the cleaning station and transport to the storage
location.

This detailed task breakdown of the activity "clean concrete forms" would not
generally be done in standard construction planning, but it is essential in the
process of programming or designing a robot to undertake this activity since the
various specific tasks must be well defined for a robot implementation. [5]

It is generally advantageous to introduce an explicit hierarchy of work activities for

the purpose of simplifying the presentation and development of a schedule. For
example, the initial plan might define a single activity associated with "site
clearance." Later, this single activity might be sub-divided into "re-locating
utilities," "removing vegetation," "grading", etc. However, these activities could
continue to be identified as sub-activities under the general activity of "site
clearance." This hierarchical structure also facilitates the preparation of summary
charts and reports in which detailed operations are combined into aggregate or
"super"-activities.

More formally, a hierarchical approach to work task definition decomposes the

work activity into component parts in the form of a tree. Higher levels in the tree
represent decision nodes or summary activities, while branches in the tree lead to
smaller components and work activities. A variety of constraints among the various
nodes may be defined or imposed, including precedence relationships among
different tasks as defined below. Technology choices may be decomposed to
decisions made at particular nodes in the tree. For example, choices on plumbing
technology might be made without reference to choices for other functional
activities.

Of course, numerous different activity hierarchies can be defined for each

construction plan. For example, upper level activities might be related to facility
components such as foundation elements, and then lower level activity divisions
into the required construction operations might be made. Alternatively, upper level
divisions might represent general types of activities such as electrical work, while
lower work divisions represent the application of these operations to specific

309
facility components. As a third alternative, initial divisions might represent
different spatial locations in the planned facility. The choice of a hierarchy depends
upon the desired scheme for summarizing work information and on the
convenience of the planner. In computerized databases, multiple hierarchies can be
stored so that different aggregations or views of the work breakdown structure can
be obtained.

The number and detail of the activities in a construction plan is a matter of

judgment or convention. Construction plans can easily range between less than a
hundred to many thousand defined tasks, depending on the planner's decisions and
the scope of the project. If subdivided activities are too refined, the size of the
network becomes unwieldy and the cost of planning excessive. Sub-division yields
no benefit if reasonably accurate estimates of activity durations and the required
resources cannot be made at the detailed work breakdown level. On the other hand,
if the specified activities are too coarse, it is impossible to develop realistic
schedules and details of resource requirements during the project. More detailed
task definitions permit better control and more realistic scheduling. It is useful to
define separate work tasks for:

• those activities which involve different resources, or

• those activities which do not require continuous performance.

For example, the activity "prepare and check shop drawings" should be divided into
a task for preparation and a task for checking since different individuals are
involved in the two tasks and there may be a time lag between preparation and
checking.

In practice, the proper level of detail will depend upon the size, importance and
difficulty of the project as well as the specific scheduling and accounting
procedures which are adopted. However, it is generally the case that most schedules
are prepared with too little detail than too much. It is important to keep in mind that
task definition will serve as the basis for scheduling, for communicating the
construction plan and for construction monitoring. Completion of tasks will also
often serve as a basis for progress payments from the owner. Thus, more detailed
task definitions can be quite useful. But more detailed task breakdowns are only
valuable to the extent that the resources required, durations and activity
relationships are realistically estimated for each activity. Providing detailed work
task breakdowns is not helpful without a commensurate effort to provide realistic
resource requirement estimates. As more powerful, computer-based scheduling and
monitoring procedures are introduced, the ease of defining and manipulating tasks
will increase, and the number of work tasks can reasonably be expected to expand.

Example 9-3: Task Definition for a Road Building Project

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As an example of construction planning, suppose that we wish to develop a plan for
a road construction project including two culverts. [6] Initially, we divide project
activities into three categories as shown in Figure 9-2: structures, roadway, and
general. This division is based on the major types of design elements to be
constructed. Within the roadway work, a further sub-division is into earthwork and
pavement. Within these subdivisions, we identify clearing, excavation, filling and
finishing (including seeding and sodding) associated with earthwork, and we define
watering, compaction and paving sub-activities associated with pavement. Finally,
we note that the roadway segment is fairly long, and so individual activities can be
defined for different physical segments along the roadway path. In Figure 9-2, we
divide each paving and earthwork activity into activities specific to each of two
roadway segments. For the culvert construction, we define the sub-divisions of
structural excavation, concreting, and reinforcing. Even more specifically,
structural excavation is divided into excavation itself and the required backfill and
compaction. Similarly, concreting is divided into placing concrete forms, pouring
concrete, stripping forms, and curing the concrete. As a final step in the structural
planning, detailed activities are defined for reinforcing each of the two culverts.
General work activities are defined for move in, general supervision, and clean up.
As a result of this planning, over thirty different detailed activities have been
defined.

At the option of the planner, additional activities might also be defined for this
project. For example, materials ordering or lane striping might be included as
separate activities. It might also be the case that a planner would define a different
hierarchy of work breakdowns than that shown in Figure 9-2. For example, placing
reinforcing might have been a sub-activity under concreting for culverts. One
reason for separating reinforcement placement might be to emphasize the different
material and resources required for this activity. Also, the division into separate
roadway segments and culverts might have been introduced early in the hierarchy.
With all these potential differences, the important aspect is to insure that all
necessary activities are included somewhere in the final plan.

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 Figure 9-2 Illustrative Hierarchical Activity Divisions for a Roadway Project

Back to top

9.4 Defining Precedence Relationships Among Activities

Once work activities have been defined, the relationships among the activities can
be specified. Precedence relations between activities signify that the activities must
take place in a particular sequence. Numerous natural sequences exist for
construction activities due to requirements for structural integrity, regulations, and
other technical requirements. For example, design drawings cannot be checked
before they are drawn. Diagramatically, precedence relationships can be illustrated
by a network or graph in which the activities are represented by arrows as in Figure
9-0. The arrows in Figure 9-3 are called branches or links in the activity network,

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while the circles marking the beginning or end of each arrow are
called nodes or events. In this figure, links represent particular activities, while the
nodes represent milestone events.

Figure 9-3 Illustrative Set of Four Activities with Precedences

More complicated precedence relationships can also be specified. For example, one
activity might not be able to start for several days after the completion of another
activity. As a common example, concrete might have to cure (or set) for several
days before formwork is removed. This restriction on the removal of forms activity
is called a lag between the completion of one activity (i.e., pouring concrete in this
case) and the start of another activity (i.e., removing formwork in this case). Many
computer based scheduling programs permit the use of a variety of precedence
relationships.

Three mistakes should be avoided in specifying predecessor relationships for

construction plans. First, a circle of activity precedences will result in an
impossible plan. For example, if activity A precedes activity B, activity B precedes
activity C, and activity C precedes activity A, then the project can never be started
or completed! Figure 9-4 illustrates the resulting activity network. Fortunately,
formal scheduling methods and good computer scheduling programs will find any
such errors in the logic of the construction plan.

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 Figure 9-4 Example of an Impossible Work Plan

Forgetting a necessary precedence relationship can be more insidious. For example,

suppose that installation of dry wall should be done prior to floor finishing.
Ignoring this precedence relationship may result in both activities being scheduled
at the same time. Corrections on the spot may result in increased costs or problems
of quality in the completed project. Unfortunately, there are few ways in which
precedence omissions can be found other than with checks by knowledgeable
managers or by comparison to comparable projects. One other possible but little
used mechanism for checking precedences is to conduct a physical or computer
based simulation of the construction process and observe any problems.

Finally, it is important to realize that different types of precedence relationships can

be defined and that each has different implications for the schedule of activities:

• Some activities have a necessary technical or physical relationship that

cannot be superseded. For example, concrete pours cannot proceed before
formwork and reinforcement are in place.
• Some activities have a necessary precedence relationship over a continuous
space rather than as discrete work task relationships. For example, formwork
may be placed in the first part of an excavation trench even as the excavation
equipment continues to work further along in the trench. Formwork
placement cannot proceed further than the excavation, but the two activities
can be started and stopped independently within this constraint.
• Some "precedence relationships" are not technically necessary but are
imposed due to implicit decisions within the construction plan. For example,
two activities may require the same piece of equipment so a precedence
relationship might be defined between the two to insure that they are not
scheduled for the same time period. Which activity is scheduled first is
arbitrary. As a second example, reversing the sequence of two activities may
be technically possible but more expensive. In this case, the precedence
relationship is not physically necessary but only applied to reduce costs as
perceived at the time of scheduling.

In revising schedules as work proceeds, it is important to realize that different types

of precedence relationships have quite different implications for the flexibility and
cost of changing the construction plan. Unfortunately, many formal scheduling
systems do not possess the capability of indicating this type of flexibility. As a
result, the burden is placed upon the manager of making such decisions and
insuring realistic and effective schedules. With all the other responsibilities of a
project manager, it is no surprise that preparing or revising the formal, computer
based construction plan is a low priority to a manager in such cases. Nevertheless,

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formal construction plans may be essential for good management of complicated
projects.

Example 9-4: Precedence Definition for Site Preparation and Foundation

Work

Suppose that a site preparation and concrete slab foundation construction project
consists of nine different activities:
A. Site clearing (of brush and minor debris),
B. Removal of trees,
C. General excavation,
D. Grading general area,
E. Excavation for utility trenches,
F. Placing formwork and reinforcement for concrete,
G. Installing sewer lines,
H. Installing other utilities,
I. Pouring concrete.

Activities A (site clearing) and B (tree removal) do not have preceding activities
since they depend on none of the other activities. We assume that activities C
(general excavation) and D (general grading) are preceded by activity A (site
clearing). It might also be the case that the planner wished to delay any excavation
until trees were removed, so that B (tree removal) would be a precedent activity to
C (general excavation) and D (general grading). Activities E (trench excavation)
and F (concrete preparation) cannot begin until the completion of general
excavation and tree removal, since they involve subsequent excavation and trench
preparation. Activities G (install lines) and H (install utilities) represent installation
in the utility trenches and cannot be attempted until the trenches are prepared, so
that activity E (trench excavation) is a preceding activity. We also assume that the
utilities should not be installed until grading is completed to avoid equipment
conflicts, so activity D (general grading) is also preceding activities G (install
sewers) and H (install utilities). Finally, activity I (pour concrete) cannot begin
until the sewer line is installed and formwork and reinforcement are ready, so
activities F and G are preceding. Other utilities may be routed over the slab
foundation, so activity H (install utilities) is not necessarily a preceding activity for
activity I (pour concrete). The result of our planning are the immediate precedences
shown in Table 9-1.

TABLE 9-1 Precedence Relations for a Nine-Activity Project Example

Activity Description Predecessors
A Site clearing ---
B Removal of trees ---
C General excavation A
D Grading general area A
E Excavation for utility trenches B,C

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 F Placing formwork and reinforcement for concrete B,C
G Installing sewer lines D,E
H Installing other utilities D,E
I Pouring concrete F,G

With this information, the next problem is to represent the activities in a network
diagram and to determine all the precedence relationships among the activities. One
network representation of these nine activities is shown in Figure 9-5, in which the
activities appear as branches or links between nodes. The nodes represent
milestones of possible beginning and starting times. This representation is called
anactivity-on-branch diagram. Note that an initial event beginning activity is
defined (Node 0 in Figure 9-5), while node 5 represents the completion of all
activities.

Figure 9-5 Activity-on-Branch Representation of a Nine Activity Project

Alternatively, the nine activities could be represented by nodes and predecessor

relationships by branches or links, as in Figure 9-6. The result is an activity-on-
node diagram. In Figure 9-6, new activity nodes representing the beginning and the
end of construction have been added to mark these important milestones.

These network representations of activities can be very helpful in visualizing the

various activities and their relationships for a project. Whether activities are
represented as branches (as in Figure 9-5) or as nodes (as in Figure 9-5) is largely a
matter of organizational or personal choice. Some considerations in choosing one
form or another are discussed in Chapter 10.

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 Figure 9-6 Activity-on-Node Representation of a Nine Activity Project

It is also notable that Table 9-1 lists only the immediate predecessor relationships.
Clearly, there are other precedence relationships which involve more than one
activity. For example, "installing sewer lines" (activity G) cannot be undertaken
before "site clearing" (Activity A) is complete since the activity "grading general
area" (Activity D) must precede activity G and must follow activity A. Table 9-1 is
an implicitprecedence list since only immediate predecessors are recorded. An
explicit predecessor list would include all of the preceding activities for activity G.
Table 9-2 shows all such predecessor relationships implied by the project plan. This
table can be produced by tracing all paths through the network back from a
particular activity and can be performed algorithmically. [7] For example,
inspecting Figure 9-6 reveals that each activity except for activity B depends upon
the completion of activity A.

TABLE 9-2 All Activity Precedence Relationships for a Nine-Activity Project

Predecessor Direct Successor All Successor All Predecessor
Activity Activities Activities Activities
A C,D E,F,G,H,I ---
B E,F G,H,I ---
C E,F G,H,I A
D G,H I A
E G,H I A,B,C
F I --- A,B,C
G I --- A,B,C,D,E
H --- --- A,B,C,D,E
I --- --- A,B,C,D,E,F,G

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317
9.5 Estimating Activity Durations
In most scheduling procedures, each work activity has an associated time duration.
These durations are used extensively in preparing a schedule. For example, suppose
that the durations shown in Table 9-3 were estimated for the project diagrammed in
Figure 9-0. The entire set of activities would then require at least 3 days, since the
activities follow one another directly and require a total of 1.0 + 0.5 + 0.5 + 1.0 = 3
days. If another activity proceeded in parallel with this sequence, the 3 day
minimum duration of these four activities is unaffected. More than 3 days would be
required for the sequence if there was a delay or a lag between the completion of
one activity and the start of another.

TABLE 9-3 Durations and Predecessors for a Four Activity Project Illustration
Activity Predecessor Duration (Days)
Excavate trench --- 1.0
Place formwork Excavate trench 0.5
Place reinforcing Place formwork 0.5
Pour concrete Place reinforcing 1.0

All formal scheduling procedures rely upon estimates of the durations of the
various project activities as well as the definitions of the predecessor relationships
among tasks. The variability of an activity's duration may also be considered.
Formally, the probability distribution of an activity's duration as well as the
expected or most likely duration may be used in scheduling. A probability
distribution indicates the chance that a particular activity duration will occur. In
advance of actually doing a particular task, we cannot be certain exactly how long
the task will require.

A straightforward approach to the estimation of activity durations is to keep

historical records of particular activities and rely on the average durations from this
experience in making new duration estimates. Since the scope of activities are
unlikely to be identical between different projects, unit productivity rates are
typically employed for this purpose. For example, the duration of an activity
Dij such as concrete formwork assembly might be estimated as:

(9.1)

where Aij is the required formwork area to assemble (in square yards), Pij is the
average productivity of a standard crew in this task (measured in square yards per
hour), and Nij is the number of crews assigned to the task. In some organizations,
unit production time, Tij, is defined as the time required to complete a unit of work

318
by a standard crew (measured in hours per square yards) is used as a productivity
measure such that Tij is a reciprocal of Pij.

A formula such as Eq. (9.1) can be used for nearly all construction activities.
Typically, the required quantity of work, Aij is determined from detailed
examination of the final facility design. This quantity-take-off to obtain the required
amounts of materials, volumes, and areas is a very common process in bid
preparation by contractors. In some countries, specialized quantity surveyors
provide the information on required quantities for all potential contractors and the
owner. The number of crews working, Nij, is decided by the planner. In many cases,
the number or amount of resources applied to particular activities may be modified
in light of the resulting project plan and schedule. Finally, some estimate of the
expected work productivity, Pij must be provided to apply Equation (9.1). As with
cost factors, commercial services can provide average productivity figures for
many standard activities of this sort. Historical records in a firm can also provide
data for estimation of productivities.

The calculation of a duration as in Equation (9.1) is only an approximation to the

actual activity duration for a number of reasons. First, it is usually the case that
peculiarities of the project make the accomplishment of a particular activity more
or less difficult. For example, access to the forms in a particular location may be
difficult; as a result, the productivity of assembling forms may be lower than the
average value for a particular project. Often, adjustments based on engineering
judgment are made to the calculated durations from Equation (9.1) for this reason.

In addition, productivity rates may vary in both systematic and random fashions
from the average. An example of systematic variation is the effect of learning on
productivity. As a crew becomes familiar with an activity and the work habits of
the crew, their productivity will typically improve. Figure 9-7 illustrates the type of
productivity increase that might occur with experience; this curve is called
a learning curve. The result is that productivity Pij is a function of the duration of
an activity or project. A common construction example is that the assembly of
floors in a building might go faster at higher levels due to improved productivity
even though the transportation time up to the active construction area is longer.
Again, historical records or subjective adjustments might be made to represent
learning curve variations in average productivity. [8]

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 Figure 9-7 Illustration of Productivity Changes Due to Learning

Random factors will also influence productivity rates and make estimation of
activity durations uncertain. For example, a scheduler will typically not know at the
time of making the initial schedule how skillful the crew and manager will be that
are assigned to a particular project. The productivity of a skilled designer may be
many times that of an unskilled engineer. In the absence of specific knowledge, the
estimator can only use average values of productivity.

Weather effects are often very important and thus deserve particular attention in
estimating durations. Weather has both systematic and random influences on
activity durations. Whether or not a rainstorm will come on a particular day is
certainly a random effect that will influence the productivity of many activities.
However, the likelihood of a rainstorm is likely to vary systematically from one
month or one site to the next. Adjustment factors for inclement weather as well as
meteorological records can be used to incorporate the effects of weather on
durations. As a simple example, an activity might require ten days in perfect
weather, but the activity could not proceed in the rain. Furthermore, suppose that
rain is expected ten percent of the days in a particular month. In this case, the
expected activity duration is eleven days including one expected rain day.

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Finally, the use of average productivity factors themselves cause problems in the
calculation presented in Equation (9.1). The expected value of the multiplicative
reciprocal of a variable is not exactly equal to the reciprocal of the variable's
expected value. For example, if productivity on an activity is either six in good
weather (ie., P=6) or two in bad weather (ie., P=2) and good or bad weather is
equally likely, then the expected productivity is P = (6)(0.5) + (2)(0.5) = 4, and the
reciprocal of expected productivity is 1/4. However, the expected reciprocal of
productivity is E[1/P] = (0.5)/6 + (0.5)/2 = 1/3. The reciprocal of expected
productivity is 25% less than the expected value of the reciprocal in this case! By
representing only two possible productivity values, this example represents an
extreme case, but it is always true that the use of average productivity factors in
Equation (9.1) will result in optimistic estimates of activity durations. The use of
actual averages for the reciprocals of productivity or small adjustment factors may
be used to correct for this non-linearity problem.

The simple duration calculation shown in Equation (9.1) also assumes an inverse
linear relationship between the number of crews assigned to an activity and the
total duration of work. While this is a reasonable assumption in situations for which
crews can work independently and require no special coordination, it need not
always be true. For example, design tasks may be divided among numerous
architects and engineers, but delays to insure proper coordination and
communication increase as the number of workers increase. As another example,
insuring a smooth flow of material to all crews on a site may be increasingly
difficult as the number of crews increase. In these latter cases, the relationship
between activity duration and the number of crews is unlikely to be inversely
proportional as shown in Equation (9.1). As a result, adjustments to the estimated
productivity from Equation (9.1) must be made. Alternatively, more complicated
functional relationships might be estimated between duration and resources used in
the same way that nonlinear preliminary or conceptual cost estimate models are
prepared.

One mechanism to formalize the estimation of activity durations is to employ a

hierarchical estimation framework. This approach decomposes the estimation
problem into component parts in which the higher levels in the hierarchy represent
attributes which depend upon the details of lower level adjustments and
calculations. For example, Figure 9-8 represents various levels in the estimation of
the duration of masonry construction. [9] At the lowest level, the maximum
productivity for the activity is estimated based upon general work conditions. Table
9-4 illustrates some possible maximum productivity values that might be employed
in this estimation. At the next higher level, adjustments to these maximum
productivities are made to account for special site conditions and crew
compositions; table 9-5 illustrates some possible adjustment rules. At the highest
level, adjustments for overall effects such as weather are introduced. Also shown in
Figure 9-8 are nodes to estimate down or unproductive time associated with the
masonry construction activity. The formalization of the estimation process

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illustrated in Figure 9-8 permits the development of computer aids for the
estimation process or can serve as a conceptual framework for a human estimator.

TABLE 9-4 Maximum Productivity Estimates for Masonry Work

Masonry unit Maximum produstivity
size Condition(s) achievable
8 inch block None 400 units/day/mason
6 inch Wall is "long" 430 units/day/mason
6 inch Wall is not "long" 370 units/day/mason
12 inch Labor is nonunion 300 units/day/mason
4 inch Wall is "long" 480 units/day/mason
Weather is "warm and dry"
or high-strength mortar is
used
4 inch Wall is not "long" 430 units/day/mason
Weather is "warm and dry"
or high-strength mortar is
used
4 inch Wall is "long" 370 units/day/mason
Weather is not "warm and
dry"
or high-strength mortar is not
used
4 inch Wall is not "long" 320 units/day/mason
Weather is not "warm and
dry"
or high-strength mortar is not
used
8 inch There is support from existing 1,000 units/day/mason
wall
8 inch There is no support from 750 units/day/mason
existing wall
12 inch There is support from existing 700 units/day/mason
wall
12 inch There is no support from 550
existing wall

TABLE 9-5 Possible Adjustments to Maximum Productivities for Masonry

Construction/caption>
Adjustment
magnitude
Impact Condition(s) (% of maximum)
Crew type Crew type is nonunion 15%
Job is "large"

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Crew type Crew type is union 10%
Job is "small"
Supporting There are less than two laborers per crew 20%
labor
Supporting There are more than two masons/laborers 10%
labor
Elevation Steel frame building with masonry 10%
exterior
wall has "insufficient" support labor
Elevation Solid masonry building with work on 12%
exterior uses nonunion labor
Visibility block is not covered 7%
Temperature Temperature is below 45o F 15%
Temperature Temperature is above 45o F 10%
Brick texture bricks are baked high 10%
Weather is cold or moist

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 Figure 9-8 A Hierarchical Estimation Framework for Masonry Construction

In addition to the problem of estimating the expected duration of an activity, some

scheduling procedures explicitly consider the uncertainty in activity duration
estimates by using the probabilistic distribution of activity durations. That is, the
duration of a particular activity is assu med to be a random variable that is
distributed in a particular fashion. For example, an activity duration might be
assumed to be distributed as a normal or a beta distributed random variable as
illustrated in Figure 9-9. This figure shows the probability or chance of
experiencing a particular activity duration based on a probabilistic distribution. The
beta distribution is often used to characterize activity durations, since it can have an
absolute minimum and an absolute maximum of possible duration times. The
normal distribution is a good approximation to the beta distribution in the center of
the distribution and is easy to work with, so it is often used as an approximation.

Figure 9-9 Beta and Normally Distributed Activity Durations

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If a standard random variable is used to characterize the distribution of activity
durations, then only a few parameters are required to calculate the probability of
any particular duration. Still, the estimation problem is increased considerably
since more than one parameter is required to characterize most of the probabilistic
distribution used to represent activity durations. For the beta distribution, three or
four parameters are required depending on its generality, whereas the normal
distribution requires two parameters.

As an example, the normal distribution is characterized by two parameters,

and representing the average duration and the standard deviation of the duration,
respectively. Alternatively, the variance of the distribution could be used to
describe or characterize the variability of duration times; the variance is the value
of the standard deviation multiplied by itself. From historical data, these two
parameters can be estimated as:

(9.2)

(9.3)

where we assume that n different observations xk of the random variable x are

available. This estimation process might be applied to activity durations directly (so
that xk would be a record of an activity duration Dij on a past project) or to the
estimation of the distribution of productivities (so that xk would be a record of the
productivity in an activity Pi) on a past project) which, in turn, is used to estimate
durations using Equation (9.4). If more accuracy is desired, the estimation
equations for mean and standard deviation, Equations (9.2) and (9.3) would be used
to estimate the mean and standard deviation of the reciprocal of productivity to
avoid non-linear effects. Using estimates of productivities, the standard deviation
of activity duration would be calculated as:

(9.4)

where is the estimated standard deviation of the reciprocal of productivity

that is calculated from Equation (9.3) by substituting 1/P for x.

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Back to top

9.6 Estimating Resource Requirements for Work Activities

In addition to precedence relationships and time durations, resource
requirements are usually estimated for each activity. Since the work activities
defined for a project are comprehensive, the total resources required for the project
are the sum of the resources required for the various activities. By making resource
requirement estimates for each activity, the requirements for particular resources
during the course of the project can be identified. Potential bottlenecks can thus be
identified, and schedule, resource allocation or technology changes made to avoid
problems.

Many formal scheduling procedures can incorporate constraints imposed by the

availability of particular resources. For example, the unavailability of a specific
piece of equipment or crew may prohibit activities from being undertaken at a
particular time. Another type of resource is space. A planner typically will schedule
only one activity in the same location at the same time. While activities requiring
the same space may have no necessary technical precedence, simultaneous work
might not be possible. Computational procedures for these various scheduling
problems will be described in Chapters 10 and 11. In this section, we shall discuss
the estimation of required resources.

The initial problem in estimating resource requirements is to decide the extent and
number of resources that might be defined. At a very aggregate level, resources
categories might be limited to the amount of labor (measured in man-hours or in
dollars), the amount of materials required for an activity, and the total cost of the
activity. At this aggregate level, the resource estimates may be useful for purposes
of project monitoring and cash flow planning. For example, actual expenditures on
an activity can be compared with the estimated required resources to reveal any
problems that are being encountered during the course of a project. Monitoring
procedures of this sort are described in Chapter 12. However, this aggregate
definition of resource use would not reveal bottlenecks associated with particular
types of equipment or workers.

More detailed definitions of required resources would include the number and type
of both workers and equipment required by an activity as well as the amount and
types of materials. Standard resource requirements for particular activities can be
recorded and adjusted for the special conditions of particular projects. As a result,
the resources types required for particular activities may already be defined.
Reliance on historical or standard activity definitions of this type requires a
standard coding system for activities.

In making adjustments for the resources required by a particular activity, most of

the problems encountered in forming duration estimations described in the previous

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section are also present. In particular, resources such as labor requirements will
vary in proportion to the work productivity, Pij, used to estimate activity durations
in Equation (9.1). Mathematically, a typical estimating equation would be:

(9.5)

where Rkij are the resources of type k required by activity ij, Dij is the duration of
activity ij, Nij is the number of standard crews allocated to activity ij, and Ukij is the
amount of resource type k used per standard crew. For example, if an activity
required eight hours with two crews assigned and each crew required three
workers, the effort would be R = 8*2*3 = 48 labor-hours.

From the planning perspective, the important decisions in estimating resource

requirements are to determine the type of technology and equipment to employ and
the number of crews to allocate to each task. Clearly, assigning additional crews
might result in faster completion of a particular activity. However, additional crews
might result in congestion and coordination problems, so that work productivity
might decline. Further, completing a particular activity earlier might not result in
earlier completion of the entire project, as discussed in Chapter 10.

Example 9-5: Resource Requirements for Block Foundations

In placing concrete block foundation walls, a typical crew would consist of three
bricklayers and two bricklayer helpers. If sufficient space was available on the site,
several crews could work on the same job at the same time, thereby speeding up
completion of the activity in proportion to the number of crews. In more restricted
sites, multiple crews might interfere with one another. For special considerations
such as complicated scaffolding or large blocks (such as twelve inch block), a
bricklayer helper for each bricklayer might be required to insure smooth and
productive work. In general, standard crew composition depends upon the specific
construction task and the equipment or technology employed. These standard crews
are then adjusted in response to special characteristics of a particular site.

Example 9-6: Pouring Concrete Slabs

For large concrete pours on horizontal slabs, it is important to plan the activity so
that the slab for a full block can be completed continuously in a single day.
Resources required for pouring the concrete depend upon the technology used. For
example, a standard crew for pumping concrete to the slab might include a
foreman, five laborers, one finisher, and one equipment operator. Related
equipment would be vibrators and the concrete pump itself. For delivering concrete
with a chute directly from the delivery truck, the standard crew might consist of a
foreman, four laborers and a finisher. The number of crews would be chosen to

327
insure that the desired amount of concrete could be placed in a single day. In
addition to the resources involved in the actual placement, it would also be
necessary to insure a sufficient number of delivery trucks and availability of the
concrete itself.
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9.7 Coding Systems

One objective in many construction planning efforts is to define the plan within the
constraints of a universal coding system for identifying activities. Each activity
defined for a project would be identified by a pre-defined code specific to that
activity. The use of a common nomenclature or identification system is basically
motivated by the desire for better integration of organizational efforts and improved
information flow. In particular, coding systems are adopted to provide a numbering
system to replace verbal descriptions of items. These codes reduce the length or
complexity of the information to be recorded. A common coding system within an
organization also aids consistency in definitions and categories between projects
and among the various parties involved in a project. Common coding systems also
aid in the retrieval of historical records of cost, productivity and duration on
particular activities. Finally, electronic data storage and retrieval operations are
much more efficient with standard coding systems, as described in Chapter 14.

In North America, the most widely used standard coding system for constructed
facilities is the MASTERFORMAT system developed by the Construction
Specifications Institute (CSI) of the United States and Construction Specifications
of Canada. [10] After development of separate systems, this combined system was
originally introduced as the Uniform Construction Index (UCI) in 1972 and was
subsequently adopted for use by numerous firms, information providers,
professional societies and trade organizations. The term MASTERFORMAT was
introduced with the 1978 revision of the UCI codes. MASTERFORMAT provides
a standard identification code for nearly all the elements associated with building
construction.

MASTERFORMAT involves a hierarchical coding system with multiple levels

plus keyword text descriptions of each item. In the numerical coding system, the
first two digits represent one of the sixteen divisions for work; a seventeenth
division is used to code conditions of the contract for a constructor. In the latest
version of the MASTERFORMAT, a third digit is added to indicate a subdivision
within each division. Each division is further specified by a three digit extension
indicating another level of subdivisions. In many cases, these subdivisions are
further divided with an additional three digits to identify more specific work items
or materials. For example, the code 16-950-960, "Electrical Equipment Testing" are
defined as within Division 16 (Electrical) and Sub-Division 950 (Testing). The
keywords "Electrical Equipment Testing" is a standard description of the activity.
The seventeen major divisions in the UCI/CSI MASTERFORMAT system are

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shown in Table 9-6. As an example, site work second level divisions are shown in
Table 9-7.

TABLE 9-6 Major Divisions in the Uniform Construction Index

0 Conditions of the contract 9 Finishes
1 General requirements 10 Specialties
2 Site work 11 Equipment
3 Concrete 12 Furnishings
4 Masonry 13 Special construction
5 Metals 14 Conveying system
6 Wood and plastics 15 Mechanical
7 Thermal and moisture prevention 16 Electrical
8 Doors and windows

While MASTERFORMAT provides a very useful means of organizing and

communicating information, it has some obvious limitations as a complete project
coding system. First, more specific information such as location of work or
responsible organization might be required for project cost control. Code
extensions are then added in addition to the digits in the basic MASTERFORMAT
codes. For example, a typical extended code might have the following elements:

0534.02220.21.A.00.cf34

The first four digits indicate the project for this activity; this code refers to an
activity on project number 0534. The next five digits refer to the
MASTERFORMAT secondary division; referring to Table 9-7, this activity would
be 02220 "Excavating, Backfilling and Compacting." The next two digits refer to
specific activities defined within this MASTERFORMAT code; the digits 21 in this
example might refer to excavation of column footings. The next character refers to
the block or general area on the site that the activity will take place; in this case,
block A is indicated. The digits 00 could be replaced by a code to indicate the
responsible organization for the activity. Finally, the characters cf34 refer to the
particular design element number for which this excavation is intended; in this
case, column footing number 34 is intended. Thus, this activity is to perform the
excavation for column footing number 34 in block A on the site. Note that a
number of additional activities would be associated with column footing 34,
including formwork and concreting. Additional fields in the coding systems might
also be added to indicate the responsible crew for this activity or to identify the
specific location of the activity on the site (defined, for example, as x, y and z
coordinates with respect to a base point).

As a second problem, the MASTERFORMAT system was originally designed for

building construction activities, so it is difficult to include various construction
activities for other types of facilities or activities associated with planning or
design. Different coding systems have been provided by other organizations in

329
particular sub-fields such as power plants or roadways. Nevertheless,
MASTERFORMAT provides a useful starting point for organizing information in
different construction domains.

In devising organizational codes for project activities, there is a continual tension

between adopting systems that are convenient or expedient for one project or for
one project manager and systems appropriate for an entire organization. As a
general rule, the record keeping and communication advantages of standard
systems are excellent arguments for their adoption. Even in small projects,
however, ad hoc or haphazard coding systems can lead to problems as the system is
revised and extended over time.

TABLE 9-7 Secondary Divisions in MASTERFORMAT for Site Work [11]

02-010 Subsurface investigation 02-350 Piles and caissons
02-012 Standard penetration tests 02-355 Pile driving
02-016 Seismic investigation 02-360 Driven piles
02-050 Demolition 02-370 Bored/augered piles
02-060 Building demolition 02-380 Caissons
02-070 Selective demolition 02-450 Railroad work
02-075 Concrete removal 02-480 Marine work
02-080 Asbestos removal
02-500 Paving and surfacing
02-100 Site preparation 02-510 Walk, road and parking paving
02-110 Site clearing 02-515 Unit pavers
02-115 Selective clearing 02-525 Curbs
02-120 Structure moving 02-530 Athletic paving and surfacing
02-140 Dewatering 02-540 Synthetic surfacing
02-150 Shoring and underpinning 02-545 Surfacing
02-550 Highway paving
02-160 Excavation supporting system 02-560 Airfield paving
02-170 Cofferdams 02-575 Pavement repair
02-200 Earthwork 02-580 Pavement marking
02-210 Grading 02-600 Piped utility materials
02-220 Excavating, backfilling and 02-660 Water distribution
02-230 compaction
02-240 Base course 02-680 Fuel distribution
02-250 Soil stabilization 02-700 Sewage and drainage
02-270 Vibro-floatation 02-760 Restoration of underground
02-280 Slope protection pipelines
02-290 Soil treatment
Earth dams 02-770 Ponds and reservoirs
02-300 Tunneling 02-800 Power and communications
02-305 Tunnel ventilation 02-880 Site improvements
02-310 Tunnel excavating 02-900 Landscaping
02-320 Tunnel lining
02-330 Tunnel grouting
02-340 Tunnel support systems

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Back to top

9.8 References
1. Baracco-Miller, E., "Planning for Construction," Unpublished MS Thesis,
Dept. of Civil Engineering, Carnegie Mellon University, 1987.
2. Construction Specifications Institute, MASTERFORMAT - Master List of
Section Titles and Numbers, Releasing Industry Group, Alexandria, VA,
1983.
3. Jackson, M.J. Computers in Construction Planning and Control, Allen &
Unwin, London, 1986.
4. Sacerdoti, E.D. A Structure for Plans and Behavior, Elsevier North-Holland,
New York, 1977.
5. Zozaya-Gorostiza, C., "An Expert System for Construction Project
Planning," Unpublished PhD Dissertation, Dept. of Civil Engineering,
Carnegie Mellon University, 1988.

Back to top

9.9 Problems
1. Develop an alternative work breakdown for the activities shown in Figure 9-
2 (Example 9-3). Begin first with a spatial division on the site (i.e. by
roadway segment and structure number), and then include functional
divisions to develop a different hierarchy of activities.

2. Consider a cold weather structure built by inflating a special rubber tent,

spraying water on the tent, letting the water freeze, and then de-flating and
removing the tent. Develop a work breakdown for this structure, precedence
relationships, and estimate the required resources. Assume that the tent is
twenty feet by fifteen feet by eight feet tall.

3. Develop a work breakdown and activity network for the project of designing
a tower to support a radio transmission antenna.

4. Select a vacant site in your vicinity and define the various activities and
precedences among these activities that would be required to prepare the site

331
 for the placement of pre-fabricated residences. Use the coding system for site
work shown in Table 9-7 for executing this problem.

5. Develop precedence relationships for the roadway project activities

appearing in Figure 9-2 (Example 9-3).

6. Suppose that you have a robot capable of performing two tasks in

manipulating blocks on a large tabletop:
o PLACE BLOCK X ON BLOCK Y: This action places the block x on
top of the block y. Preconditions for applying this action are that both
block x and block y have clear tops (so there is no block on top of x or
y). The robot will automatically locate the specified blocks.
o CLEAR BLOCK X: This action removes any block from the top of
block x. A necessary precondition for this action is that block x has
one and only one block on top. The block removed is placed on the
table top.

For this robot, answer the following questions:

1. Using only the two robot actions, specify a sequence of robot actions
to take the five blocks shown in Figure 9-10(a) to the position shown in
Figure 9-10(b) in five or six robot actions.
2. Specify a sequence of robot actions to move the blocks from position
(b) to position (c) in Figure 9-10 in six moves.
3. Develop an activity network for the robot actions in moving from
position (b) to position (c) in Figure 9-10. Prepare both activity-on-
node and activity-on-link representations. Are there alternative
sequences of activities that the robot might perform to accomplish the
desired position?

332
 Figure 9-10 Illustrative Block Positions for Robot Motion Planning

2. In the previous problem, suppose that switching from the PLACE BLOCK
action to the CLEAR BLOCK action or vice versa requires an extra ten
seconds. Movements themselves require 8 seconds. What is the sequence of
actions of shortest duration to go from position (b) to position (a) in Figure
9-10?

3. Repeat Problem 6 above for the movement from position (a) to position (c)
in Figure 9-10.

4. Repeat Problem 7 above for the movement from position (a) to position (c)
in Figure 9-10.

5. Suppose that you have an enhanced robot with two additional commands
capabilities:

333
 o CARRY BLOCKS X-Y to BLOCK Z: This action moves blocks X-Y
to the top of block Z. Blocks X-Y may involve any number of blocks
as long as X is on the bottom and Y is on the top. This move assumes
that Z has a clear top.
o CLEAR ALL BLOCK X TO BLOCK Z: This action moves all blocks
on top of block X to the top of block Z. If a block Z is not specified,
then the blocks are moved to the table top.

How do these capabilities change your answer to Problems 6 and 7?

7. How does the additional capability described in Problem 10 change your

answer to Problems 8 and ?

Back to top

9.10 Footnotes
1. A.C. Doyle, "A Study in Scarlet," The Complete Sherlock Holmes, Doubleday &
Co., pg. 83, 1930. Back

2. See, for example, Paulson, B.C., S.A. Douglas, A. Kalk, A. Touran and G.A.
Victor, "Simulation and Analysis of Construction Operations," ASCE Journal of
Technical Topics in Civil Engineering, 109(2), August, 1983, pp. 89, or Carr, R.I.,
"Simulation of Construction Project Duration," ASCE Journal of the Construction
Division, 105(2), June 1979, 117-128. Back

3. For a description of a laser leveling system, see Paulson, B.C., Jr., "Automation
and Robotics for Construction," ASCE Journal of Construction Engineering and
Management, (111)3, pp. 190-207, Sept. 1985.Back

4. See Baker, K.R., Introduction to Sequencing and Scheduling, John-Wiley and

Sons, New York, 1974, for an introduction to scheduling in manufacturing. Back

5. See Skibniewski, M.J. and C.T. Hendrickson, "Evaluation Method for Robotics
Implementation: Application to Concrete Form Cleaning," Proc. Second Intl. Conf.
on Robotics in Construction, Carnegie-Mellon University, Pittsburgh, PA., 1985,
for more detail on the work process design of a concrete form cleaning robot. Back

6. This example is adapted from Aras, R. and J. Surkis, "PERT and CPM
Techniques in Project Management," ASCE Journal of the Construction
Division, Vol. 90, No. CO1, March, 1964. Back

334
7. For a discussion of network reachability and connectivity computational
algorithms, see Chapters 2 and 7 in N. Christofides, Graph Theory: An Algorithmic
Approach, London: Academic Press, 1975, or any other text on graph theory. Back

8. See H.R. Thomas, C.T. Matthews and J.G. Ward, "Learning Curve Models of
Construction Productivity," ASCE Journal of Construction Engineering and
Management, Vol. 112, No. 2, June 1986, pp. 245-258.Back

9. For a more extension discussion and description of this estimation procedure, see
Hendrickson, C., D. Martinelli, and D. Rehak, "Hierarchical Rule-based Activity
Duration Estimation," ASCE Journal of Construction Engineering and
Management, Vol 113, No. 2, 1987,pp. 288-301. Back

10. Information on the MASTERFORMAT coding system can be obtained from:

The Construction Specifications Institute, 601 Madison St., Alexandria VA
22314. Back

11. Source: MASTERFORMAT: Master List of Section Titles and Numbers, 1983
Edition, The construction Speculations Institute, Alexandria, VA, 1983. Back

335
10. Fundamental Scheduling Procedures
10.1 Relevance of Construction Schedules
In addition to assigning dates to project activities, project scheduling is intended to
match the resources of equipment, materials and labor with project work tasks over
time. Good scheduling can eliminate problems due to production bottlenecks,
facilitate the timely procurement of necessary materials, and otherwise insure the
completion of a project as soon as possible. In contrast, poor scheduling can result
in considerable waste as laborers and equipment wait for the availability of needed
resources or the completion of preceding tasks. Delays in the completion of an
entire project due to poor scheduling can also create havoc for owners who are
eager to start using the constructed facilities.

Attitudes toward the formal scheduling of projects are often extreme. Many owners
require detailed construction schedules to be submitted by contractors as a means of
monitoring the work progress. The actual work performed is commonly compared
to the schedule to determine if construction is proceeding satisfactorily. After the
completion of construction, similar comparisons between the planned schedule and
the actual accomplishments may be performed to allocate the liability for project
delays due to changes requested by the owner, worker strikes or other unforeseen
circumstances.

In contrast to these instances of reliance upon formal schedules, many field

supervisors disdain and dislike formal scheduling procedures. In particular,
the critical path method of scheduling is commonly required by owners and has
been taught in universities for over two decades, but is often regarded in the field as
irrelevant to actual operations and a time consuming distraction. The result is "seat-
of-the-pants" scheduling that can be good or that can result in grossly inefficient
schedules and poor productivity. Progressive construction firms use formal
scheduling procedures whenever the complexity of work tasks is high and the
coordination of different workers is required.

Formal scheduling procedures have become much more common with the advent
of personal computers on construction sites and easy-to-use software programs.
Sharing schedule information via the Internet has also provided a greater incentive
to use formal scheduling methods. Savvy construction supervisors often carry
schedule and budget information around with wearable or handheld computers. As
a result, the continued development of easy to use computer programs and
improved methods of presenting schedules hav overcome the practical problems
associated with formal scheduling mechanisms. But problems with the use of
scheduling techniques will continue until managers understand their proper use and
limitations.

336
A basic distinction exists between resource oriented and time oriented scheduling
techniques. For resource oriented scheduling, the focus is on using and scheduling
particular resources in an effective fashion. For example, the project manager's
main concern on a high-rise building site might be to insure that cranes are used
effectively for moving materials; without effective scheduling in this case, delivery
trucks might queue on the ground and workers wait for deliveries on upper floors.
For time oriented scheduling, the emphasis is on determining the completion time
of the project given the necessary precedence relationships among activities.
Hybrid techniques for resource leveling or resource constrained scheduling in the
presence of precedence relationships also exist. Most scheduling software is time-
oriented, although virtually all of the programs have the capability to introduce
resource constaints.

This chapter will introduce the fundamentals of scheduling methods. Our

discussion will generally assume that computer based scheduling programs will be
applied. Consequently, the wide variety of manual or mechanical scheduling
techniques will not be discussed in any detail. These manual methods are not as
capable or as convenient as computer based scheduling. With the availability of
these computer based scheduling programs, it is important for managers to
understand the basic operations performed by scheduling programs. Moreover,
even if formal methods are not applied in particular cases, the conceptual
framework of formal scheduling methods provides a valuable reference for a
manager. Accordingly, examples involving hand calculations will be provided
throughout the chapter to facilitate understanding.

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10.2 The Critical Path Method

The most widely used scheduling technique is the critical path method (CPM) for
scheduling, often referred to as critical path scheduling. This method calculates the
minimum completion time for a project along with the possible start and finish
times for the project activities. Indeed, many texts and managers regard critical path
scheduling as the only usable and practical scheduling procedure. Computer
programs and algorithms for critical path scheduling are widely available and can
efficiently handle projects with thousands of activities.

The critical path itself represents the set or sequence of predecessor/successor

activities which will take the longest time to complete. The duration of the critical
path is the sum of the activities' durations along the path. Thus, the critical path can
be defined as the longest possible path through the "network" of project activities,
as described in Chapter 9. The duration of the critical path represents the minimum
time required to complete a project. Any delays along the critical path would imply
that additional time would be required to complete the project.

337
There may be more than one critical path among all the project activities, so
completion of the entire project could be delayed by delaying activities along any
one of the critical paths. For example, a project consisting of two activities
performed in parallel that each require three days would have each activity critical
for a completion in three days.

Formally, critical path scheduling assumes that a project has been divided into
activities of fixed duration and well defined predecessor relationships. A
predecessor relationship implies that one activity must come before another in the
schedule. No resource constraints other than those implied by precedence
relationships are recognized in the simplest form of critical path scheduling.

To use critical path scheduling in practice, construction planners often represent

a resource constraint by a precedence relation. A constraint is simply a restriction
on the options available to a manager, and a resource constraint is a constraint
deriving from the limited availability of some resource of equipment, material,
space or labor. For example, one of two activities requiring the same piece of
equipment might be arbitrarily assumed to precede the other activity. This artificial
precedence constraint insures that the two activities requiring the same resource
will not be scheduled at the same time. Also, most critical path scheduling
algorithms impose restrictions on the generality of the activity relationships or
network geometries which are used. In essence, these restrictions imply that the
construction plan can be represented by a network plan in which activities appear
as nodes in a network, as in Figure 9-6. Nodes are numbered, and no two nodes can
have the same number or designation. Two nodes are introduced to represent the
start and completion of the project itself.

The actual computer representation of the project schedule generally consists of a

list of activities along with their associated durations, required resources and
predecessor activities. Graphical network representations rather than a list are
helpful for visualization of the plan and to insure that mathematical requirements
are met. The actual input of the data to a computer program may be accomplished
by filling in blanks on a screen menu, reading an existing datafile, or typing data
directly to the program with identifiers for the type of information being provided.

With an activity-on-branch network, dummy activities may be introduced for the

purposes of providing unique activity designations and maintaining the correct
sequence of activities. A dummy activity is assumed to have no time duration and
can be graphically represented by a dashed line in a network. Several cases in
which dummy activities are useful are illustrated in Fig. 10-1. In Fig. 10-1(a), the
elimination of activity C would mean that both activities B and D would be
identified as being between nodes 1 and 3. However, if a dummy activity X is
introduced, as shown in part (b) of the figure, the unique designations for activity B
(node 1 to 2) and D (node 1 to 3) will be preserved. Furthermore, if the problem in
part (a) is changed so that activity E cannot start until both C and D are completed

338
but that F can start after D alone is completed, the order in the new sequence can be
indicated by the addition of a dummy activity Y, as shown in part (c). In general,
dummy activities may be necessary to meet the requirements of specific computer
scheduling algorithms, but it is important to limit the number of such dummy link
insertions to the extent possible.

Figure 10-1 Dummy Activities in a Project Network

339
Many computer scheduling systems support only one network representation, either
activity-on-branch or acitivity-on-node. A good project manager is familiar with
either representation.

Example 10-1: Formulating a network diagram

Suppose that we wish to form an activity network for a seven-activity network with
the following precedences:
Activity Predecessors
A ---
B ---
C A,B
D C
E C
F D
G D,E

Forming an activity-on-branch network for this set of activities might begin be

drawing activities A, B and C as shown in Figure 10-2(a). At this point, we note
that two activities (A and B) lie between the same two event nodes; for clarity, we
insert a dummy activity X and continue to place other activities as in Figure 10-
2(b). Placing activity G in the figure presents a problem, however, since we wish
both activity D and activity E to be predecessors. Inserting an additional dummy
activity Y along with activity G completes the activity network, as shown in Figure
10-2(c). A comparable activity-on-node representation is shown in Figure 10-3,
including project start and finish nodes. Note that dummy activities are not required
for expressing precedence relationships in activity-on-node networks.

340
Figure 10-2 An Activity-on-Branch Network for Critical Path Scheduling

Figure 10-3 An Activity-on-Node Network for Critical Path Scheduling

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Back to top

10.3 Calculations for Critical Path Scheduling

With the background provided by the previous sections, we can formulate the
critical path scheduling mathematically. We shall present an algorithm or set of
instructions for critical path scheduling assuming an activity-on-branch project
network. We also assume that all precedences are of a finish-to-start nature, so that
a succeeding activity cannot start until the completion of a preceding activity. In a
later section, we present a comparable algorithm for activity-on-node
representations with multiple precedence types.

Suppose that our project network has n+1 nodes, the initial event being 0 and the
last event being n. Let the time at which node events occur be x1, x2,...., xn,
respectively. The start of the project at x0 will be defined as time 0. Nodal event
times must be consistent with activity durations, so that an activity's successor node
event time must be larger than an activity's predecessor node event time plus its
duration. For an activity defined as starting from event i and ending at event j, this
relationship can be expressed as the inequality constraint, xj xi + Dij where Dij is
the duration of activity (i,j). This same expression can be written for every activity
and must hold true in any feasible schedule. Mathematically, then, the critical path
scheduling problem is to minimize the time of project completion (xn) subject to the
constraints that each node completion event cannot occur until each of the
predecessor activities have been completed:

Minimize
(10.1)

subject to

This is a linear programming problem since the objective value to be minimized

and each of the constraints is a linear equation. [1]

Rather than solving the critical path scheduling problem with a linear programming
algorithm (such as the Simplex method), more efficient techniques are available
that take advantage of the network structure of the problem. These solution
methods are very efficient with respect to the required computations, so that very
large networks can be treated even with personal computers. These methods also
give some very useful information about possible activity schedules. The programs

342
can compute the earliest and latest possible starting times for each activity which
are consistent with completing the project in the shortest possible time. This
calculation is of particular interest for activities which are not on the critical path
(or paths), since these activities might be slightly delayed or re-scheduled over time
as a manager desires without delaying the entire project.

An efficient solution process for critical path scheduling based upon node labeling
is shown in Table 10-1. Three algorithms appear in the table. The event numbering
algorithm numbers the nodes (or events) of the project such that the beginning
event has a lower number than the ending event for each activity. Technically, this
algorithm accomplishes a "topological sort" of the activities. The project start node
is given number 0. As long as the project activities fulfill the conditions for an
activity-on-branch network, this type of numbering system is always possible.
Some software packages for critical path scheduling do not have this numbering
algorithm programmed, so that the construction project planners must insure that
appropriate numbering is done.

TABLE 10-1 Critical Path Scheduling Algorithms (Activity-on-Branch Representation)

Event Numbering Algorithm
Step 1: Give the starting event number 0.
Step 2: Give the next number to any unnumbered event whose predecessor events
are each already numbered.
Repeat Step 2 until all events are numbered.
Earliest Event Time Algorithm
Step 1: Let E(0) = 0.
Step 2: For j = 1,2,3,...,n (where n is the last event), let
E(j) = maximum {E(i) + Dij}
where the maximum is computed over all activities (i,j) that have j as the ending event.
Latest Event Time Algorithm
Step 1: Let L(n) equal the required completion time of the project.
Note: L(n) must equal or exceed E(n).
Step 2: For i = n-1, n-2, ..., 0, let
L(i) = minimum {L(j) - Dij}
where the minimum is computed over all activities (i,j) that have i as the starting event.

The earliest event time algorithm computes the earliest possible time, E(i), at which
each event, i, in the network can occur. Earliest event times are computed as the
maximum of the earliest start times plus activity durations for each of the activities
immediately preceding an event. The earliest start time for each activity (i,j) is
equal to the earliest possible time for the preceding event E(i):

(10.2)

343
The earliest finish time of each activity (i,j) can be calculated by:

(10.3)

Activities are identified in this algorithm by the predecessor node (or event) i and
the successor node j. The algorithm simply requires that each event in the network
should be examined in turn beginning with the project start (node 0).

The latest event time algorithm computes the latest possible time, L(j), at which
each event j in the network can occur, given the desired completion time of the
project, L(n) for the last event n. Usually, the desired completion time will be equal
to the earliest possible completion time, so that E(n) = L(n) for the final node n.
The procedure for finding the latest event time is analogous to that for the earliest
event time except that the procedure begins with the final event and works
backwards through the project activities. Thus, the earliest event time algorithm is
often called a forward pass through the network, whereas the latest event time
algorithm is the the backward pass through the network. The latest finish time
consistent with completion of the project in the desired time frame of L(n) for each
activity (i,j) is equal to the latest possible time L(j) for the succeeding event:

(10.4)

The latest start time of each activity (i,j) can be calculated by:

(10.5)

The earliest start and latest finish times for each event are useful pieces of
information in developing a project schedule. Events which have equal earliest and
latest times, E(i) = L(i), lie on the critical path or paths. An activity (i,j) is a critical
activity if it satisfies all of the following conditions:

(10.6)

(10.7)

(10.8)

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Hence, activities between critical events are also on a critical path as long as the
activity's earliest start time equals its latest start time, ES(i,j) = LS(i,j). To avoid
delaying the project, all the activities on a critical path should begin as soon as
possible, so each critical activity (i,j) must be scheduled to begin at the earliest
possible start time, E(i).

Example 10-2: Critical path scheduling calculations

Consider the network shown in Figure 10-4 in which the project start is given
number 0. Then, the only event that has each predecessor numbered is the
successor to activity A, so it receives number 1. After this, the only event that has
each predecessor numbered is the successor to the two activities B and C, so it
receives number 2. The other event numbers resulting from the algorithm are also
shown in the figure. For this simple project network, each stage in the numbering
process found only one possible event to number at any time. With more than one
feasible event to number, the choice of which to number next is arbitrary. For
example, if activity C did not exist in the project for Figure 10-4, the successor
event for activity A or for activity B could have been numbered 1.

Figure 10-4 A Nine-Activity Project Network

Once the node numbers are established, a good aid for manual scheduling is to
draw a small rectangle near each node with two possible entries. The left hand side
would contain the earliest time the event could occur, whereas the right hand side
would contain the latest time the event could occur without delaying the entire
project. Figure 10-5 illustrates a typical box.

345
Figure 10-5 E(i) and L(i) Display for Hand Calculation of Critical Path for
Activity-on-Branch Representation

TABLE 10-2 Precedence Relations and Durations for a Nine Activity Project Example
Activity Description Predecessors Duration
A Site clearing --- 4
B Removal of trees --- 3
C General excavation A 8
D Grading general area A 7
E Excavation for trenches B, C9
F Placing formwork and reinforcement for concrete B, C 12
G Installing sewer lines D, E2
H Installing other utilities D, E5
I Pouring concrete F, G 6

For the network in Figure 10-4 with activity durations in Table 10-2, the earliest
event time calculations proceed as follows:

Step 1 E(0) = 0
Step 2
j=1 E(1) = Max{E(0) + D01} = Max{ 0 + 4 } = 4
j=2 E(2) = Max{E(0) + D02; E(1) + D12} = Max{0 + 3; 4 + 8} = 12
j=3 E(3) = Max{E(1) + D13; E(2) + D23} = Max{4 + 7; 12 + 9} = 21
j=4 E(4) = Max{E(2) + D24; E(3) + D34} = Max{12 + 12; 21 + 2} = 24
j=5 E(5) = Max{E(3) + D35; E(4) + D45} = Max{21 + 5; 24 + 6} = 30

Thus, the minimum time required to complete the project is 30 since E(5) = 30. In
this case, each event had at most two predecessors.

For the "backward pass," the latest event time calculations are:

Step 1 L(5) = E(5) = 30

Step 2
j=4 L(4) = Min {L(5) - D45} = Min {30 - 6} = 24
j=3 L(3) = Min {L(5) - D35; L(4) - D34} = Min {30 -5; 24 - 2} = 22
j=2 L(2) = Min {L(4) - D24; L(3) - D23} = Min {24 - 12; 22 - 9} = 12
j=1 L(1) = Min {L(3) - D13; L(2) - D12} = Min {22 - 7; 12 - 8} = 4

346
j=0 L(0) = Min {L(2) - D02; L(1) - D01} = Min {12 - 3; 4 - 4} = 0

In this example, E(0) = L(0), E(1) = L(1), E(2) = L(2), E(4) = L(4),and E(5) = L(5).
As a result, all nodes but node 3 are in the critical path. Activities on the critical
path include A (0,1), C (1,2), F (2,4) and I (4,5) as shown in Table 10-3.

TABLE 10-3 Identification of Activities on the Critical Path for a Nine-Activity Project
Duration Earliest start time Latest finish time Latest start time
Activity Dij E(i)=ES(i,j) L(j)=LF(i,j) LS(i,j)
A (0,1) 4 0* 4* 0
B (0,2) 3 0 12 9
C (1,2) 8 4* 12* 4
D (1,3) 7 4 22 15
E (2,3) 9 12 22 13
F (2,4) 12 12* 24* 12
G (3,4) 2 21 24 22
H (3,5) 5 21 30 25
I (4,5) 6 24 30* 24

*Activity on a critical path since E(i) + DiJ = L(j).

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10.4 Activity Float and Schedules

A number of different activity schedules can be developed from the critical path
scheduling procedure described in the previous section. An earliest time schedule
would be developed by starting each activity as soon as possible, at ES(i,j).
Similarly, a latest time schedule would delay the start of each activity as long as
possible but still finish the project in the minimum possible time. This late schedule
can be developed by setting each activity's start time to LS(i,j).

Activities that have different early and late start times (i.e., ES(i,j) < LS(i,j)) can be
scheduled to start anytime between ES(i,j) and LS(i,j) as shown in Figure 10-6. The
concept of float is to use part or all of this allowable range to schedule an activity
without delaying the completion of the project. An activity that has the earliest time
for its predecessor and successor nodes differing by more than its duration
possesses a window in which it can be scheduled. That is, if E(i) + D ij < L(j), then
some float is available in which to schedule this activity.

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Figure 10-6 Illustration of Activity Float

Float is a very valuable concept since it represents the scheduling flexibility or

"maneuvering room" available to complete particular tasks. Activities on the
critical path do not provide any flexibility for scheduling nor leeway in case of
problems. For activities with some float, the actual starting time might be chosen to
balance work loads over time, to correspond with material deliveries, or to improve
the project's cash flow.

Of course, if one activity is allowed to float or change in the schedule, then the
amount of float available for other activities may decrease. Three separate
categories of float are defined in critical path scheduling:

1. Free float is the amount of delay which can be assigned to any one activity
without delaying subsequent activities. The free float, FF(i,j), associated
with activity (i,j) is:

(10.9)

2. Independent float is the amount of delay which can be assigned to any one
activity without delaying subsequent activities or restricting the scheduling

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 of preceding activities. Independent float, IF(i,j), for activity (i,j) is
calculated as:
(10.10)

3. Total float is the maximum amount of delay which can be assigned to any
activity without delaying the entire project. The total float, TF(i,j), for any
activity (i,j) is calculated as:

(10.11)

Each of these "floats" indicates an amount of flexibility associated with an activity.

In all cases, total float equals or exceeds free float, while independent float is
always less than or equal to free float. Also, any activity on a critical path has all
three values of float equal to zero. The converse of this statement is also true, so
any activity which has zero total float can be recognized as being on a critical path.

The various categories of activity float are illustrated in Figure 10-6 in which the
activity is represented by a bar which can move back and forth in time depending
upon its scheduling start. Three possible scheduled starts are shown, corresponding
to the cases of starting each activity at the earliest event time, E(i), the latest
activity start time LS(i,j), and at the latest event time L(i). The three categories of
float can be found directly from this figure. Finally, a fourth bar is included in the
figure to illustrate the possibility that an activity might start, be temporarily halted,
and then re-start. In this case, the temporary halt was sufficiently short that it was
less than the independent float time and thus would not interfere with other
activities. Whether or not such work splitting is possible or economical depends
upon the nature of the activity.

As shown in Table 10-3, activity D(1,3) has free and independent floats of 10 for
the project shown in Figure 10-4. Thus, the start of this activity could be scheduled
anytime between time 4 and 14 after the project began without interfering with the
schedule of other activities or with the earliest completion time of the project. As
the total float of 11 units indicates, the start of activity D could also be delayed
until time 15, but this would require that the schedule of other activities be
restricted. For example, starting activity D at time 15 would require that activity G
would begin as soon as activity D was completed. However, if this schedule was
maintained, the overall completion date of the project would not be changed.

Example 10-3: Critical path for a fabrication project

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As another example of critical path scheduling, consider the seven activities
associated with the fabrication of a steel component shown in Table 10-4. Figure
10-7 shows the network diagram associated with these seven activities. Note that an
additional dummy activity X has been added to insure that the correct precedence
relationships are maintained for activity E. A simple rule to observe is that if an
activity has more than one immediate predecessor and another activity has at least
one but not all of these predecessor activity as a predecessor, a dummy activity will
be required to maintain precedence relationships. Thus, in the figure, activity E has
activities B and C as predecessors, while activity D has only activity C as a
predecessor. Hence, a dummy activity is required. Node numbers have also been
added to this figure using the procedure outlined in Table 10-1. Note that the node
numbers on nodes 1 and 2 could have been exchanged in this numbering process
since after numbering node 0, either node 1 or node 2 could be numbered next.
TABLE 10-4 Precedences and Durations for a Seven Activity Project
Activity Description Predecessors Duration
A Preliminary design --- 6
B Evaluation of design A 1
C Contract negotiation --- 8
D Preparation of fabrication plant C 5
E Final design B, C9
F Fabrication of Product D, E 12
G Shipment of Product to owner F 3

Figure 10-7 Illustration of a Seven Activity Project Network

The results of the earliest and latest event time algorithms (appearing in Table 10-
1) are shown in Table 10-5. The minimum completion time for the project is 32
days. In this small project, all of the event nodes except node 1 are on the critical
path. Table 10-6 shows the earliest and latest start times for the various activities

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including the different categories of float. Activities C,E,F,G and the dummy
activity X are seen to lie on the critical path.

TABLE 10-5 Event Times for a Seven Activity Project

Node Earliest Time E(i) Latest Time L(j)
0 0 0
1 6 7
2 8 8
3 8 8
4 17 17
5 29 29
6 32 32

TABLE 10-6 Earliest Start, Latest Start and Activity Floats for a Seven Activity Project
Latest start time Free float
Activity Earliest start time ES(i,j) LS(i,j) Independent float Total float
A (0,1) 0 1 0 0 1
B (1,3) 6 7 1 0 1
C (0,2) 0 0 0 0 0
D (2,4) 8 12 4 4 4
E (3,4) 8 8 0 0 0
F (4,5) 17 17 0 0 0
G (5,6) 29 29 0 0 0
X (2,3) 8 8 0 0 0

Back to top

10.5 Presenting Project Schedules

Communicating the project schedule is a vital ingredient in successful project
management. A good presentation will greatly ease the manager's problem of
understanding the multitude of activities and their inter-relationships. Moreover,
numerous individuals and parties are involved in any project, and they have to
understand their assignments. Graphical presentations of project schedules are
particularly useful since it is much easier to comprehend a graphical display of
numerous pieces of information than to sift through a large table of numbers. Early
computer scheduling systems were particularly poor in this regard since they
produced pages and pages of numbers without aids to the manager for
understanding them. A short example appears in Tables 10-5 and 10-6; in practice,
a project summary table would be much longer. It is extremely tedious to read a
table of activity numbers, durations, schedule times, and floats and thereby gain an
understanding and appreciation of a project schedule. In practice, producing
diagrams manually has been a common prescription to the lack of automated

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drafting facilities. Indeed, it has been common to use computer programs to
perform critical path scheduling and then to produce bar charts of detailed activity
schedules and resource assignments manually. With the availability of computer
graphics, the cost and effort of producing graphical presentations has been
significantly reduced and the production of presentation aids can be automated.

Network diagrams for projects have already been introduced. These diagrams
provide a powerful visualization of the precedences and relationships among the
various project activities. They are a basic means of communicating a project plan
among the participating planners and project monitors. Project planning is often
conducted by producing network representations of greater and greater refinement
until the plan is satisfactory.

A useful variation on project network diagrams is to draw a time-scaled network.

The activity diagrams shown in the previous section were topological networks in
that only the relationship between nodes and branches were of interest. The actual
diagram could be distorted in any way desired as long as the connections between
nodes were not changed. In time-scaled network diagrams, activities on the
network are plotted on a horizontal axis measuring the time since project
commencement. Figure 10-8 gives an example of a time-scaled activity-on-branch
diagram for the nine activity project in Figure 10-4. In this time-scaled diagram,
each node is shown at its earliest possible time. By looking over the horizontal axis,
the time at which activity can begin can be observed. Obviously, this time scaled
diagram is produced as a display after activities are initially scheduled by the
critical path method.

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Figure 10-8 Illustration of a Time Scaled Network Diagram with Nine Activities

Another useful graphical representation tool is a bar or Gantt chart illustrating the
scheduled time for each activity. The bar chart lists activities and shows their
scheduled start, finish and duration. An illustrative bar chart for the nine activity
project appearing in Figure 10-4 is shown in Figure 10-9. Activities are listed in the
vertical axis of this figure, while time since project commencement is shown along
the horizontal axis. During the course ofmonitoring a project, useful additions to
the basic bar chart include a vertical line to indicate the current time plus small
marks to indicate the current state of work on each activity. In Figure 10-9, a
hypothetical project state after 4 periods is shown. The small "v" marks on each
activity represent the current state of each activity.

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Figure 10-9 An Example Bar Chart for a Nine Activity Project

Bar charts are particularly helpful for communicating the current state and schedule
of activities on a project. As such, they have found wide acceptance as a project
representation tool in the field. For planning purposes, bar charts are not as useful
since they do not indicate the precedence relationships among activities. Thus, a
planner must remember or record separately that a change in one activity's schedule
may require changes to successor activities. There have been various schemes for
mechanically linking activity bars to represent precedences, but it is now easier to
use computer based tools to represent such relationships.

Other graphical representations are also useful in project monitoring. Time and
activity graphs are extremely useful in portraying the current status of a project as
well as the existence of activity float. For example, Figure 10-10 shows two

354
possible schedules for the nine activity project described in Table 9-1 and shown in
the previous figures. The first schedule would occur if each activity was scheduled
at its earliest start time, ES(i,j) consistent with completion of the project in the
minimum possible time. With this schedule, Figure 10-10 shows the percent of
project activity completed versus time. The second schedule in Figure 10-10 is
based on latest possible start times for each activity, LS(i,j). The horizontal time
difference between the two feasible schedules gives an indication of the extent of
possible float. If the project goes according to plan, the actual percentage
completion at different times should fall between these curves. In practice, a
vertical axis representing cash expenditures rather than percent completed is often
used in developing a project representation of this type. For this purpose, activity
cost estimates are used in preparing a time versus completion graph. Separate "S-
curves" may also be prepared for groups of activities on the same graph, such as
separate curves for the design, procurement, foundation or particular sub-contractor
activities.

Figure 10-10 Example of Percentage Completion versus Time for Alternative

Schedules with a Nine Activity Project

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Time versus completion curves are also useful in project monitoring. Not only the
history of the project can be indicated, but the future possibilities for earliest and
latest start times. For example, Figure 10-11 illustrates a project that is forty
percent complete after eight days for the nine activity example. In this case, the
project is well ahead of the original schedule; some activities were completed in
less than their expected durations. The possible earliest and latest start time
schedules from the current project status are also shown on the figure.

Figure 10-11 Illustration of Actual Percentage Completion versus Time for a Nine
Activity Project Underway

Graphs of resource use over time are also of interest to project planners and
managers. An example of resource use is shown in Figure 10-12 for the resource of
total employment on the site of a project. This graph is prepared by summing the
resource requirements for each activity at each time period for a particular project
schedule. With limited resources of some kind, graphs of this type can indicate
when the competition for a resource is too large to accommodate; in cases of this
kind, resource constrained scheduling may be necessary as described in Section

356
10.9. Even without fixed resource constraints, a scheduler tries to avoid extreme
fluctuations in the demand for labor or other resources since these fluctuations
typically incur high costs for training, hiring, transportation, and management.
Thus, a planner might alter a schedule through the use of available activity floats so
as to level or smooth out the demand for resources. Resource graphs such as Figure
10-12 provide an invaluable indication of the potential trouble spots and the
success that a scheduler has in avoiding them.

Figure 10-12 Illustration of Resource Use over Time for a Nine Activity Project

A common difficulty with project network diagrams is that too much information is
available for easy presentation in a network. In a project with, say, five hundred
activities, drawing activities so that they can be seen without a microscope requires
a considerable expanse of paper. A large project might require the wall space in a
room to include the entire diagram. On a computer display, a typical restriction is
that less than twenty activities can be successfully displayed at the same time. The
problem of displaying numerous activities becomes particularly acute when
accessory information such as activity identifying numbers or phrases, durations
and resources are added to the diagram.

One practical solution to this representation problem is to define sets of activities

that can be represented together as a single activity. That is, for display purposes,
network diagrams can be produced in which one "activity" would represent a

357
number of real sub-activities. For example, an activity such as "foundation design"
might be inserted in summary diagrams. In the actual project plan, this one activity
could be sub-divided into numerous tasks with their own precedences, durations
and other attributes. These sub-groups are sometimes termed fragnets for fragments
of the full network. The result of this organization is the possibility of producing
diagrams that summarize the entire project as well as detailed representations of
particular sets of activities. The hierarchy of diagrams can also be introduced to the
production of reports so that summary reports for groups of activities can be
produced. Thus, detailed representations of particular activities such as plumbing
might be prepared with all other activities either omitted or summarized in larger,
aggregate activity representations. The CSI/MASTERSPEC activity definition
codes described in Chapter 9 provide a widely adopted example of a hierarchical
organization of this type. Even if summary reports and diagrams are prepared, the
actual scheduling would use detailed activity characteristics, of course.

An example figure of a sub-network appears in Figure 10-13. Summary displays

would include only a single node A to represent the set of activities in the sub-
network. Note that precedence relationships shown in the master network would
have to be interpreted with care since a particular precedence might be due to an
activity that would not commence at the start of activity on the sub-network.

Figure 10-13 Illustration of a Sub-Network in a Summary Diagram

The use of graphical project representations is an important and extremely useful

aid to planners and managers. Of course, detailed numerical reports may also be
required to check the peculiarities of particular activities. But graphs and diagrams

358
provide an invaluable means of rapidly communicating or understanding a project
schedule. With computer based storage of basic project data, graphical output is
readily obtainable and should be used whenever possible.

Finally, the scheduling procedure described in Section 10.3 simply counted days
from the initial starting point. Practical scheduling programs include a calendar
conversion to provide calendar dates for scheduled work as well as the number of
days from the initiation of the project. This conversion can be accomplished by
establishing a one-to-one correspondence between project dates and calendar dates.
For example, project day 2 would be May 4 if the project began at time 0 on May 2
and no holidays intervened. In this calendar conversion, weekends and holidays
would be excluded from consideration for scheduling, although the planner might
overrule this feature. Also, the number of work shifts or working hours in each day
could be defined, to provide consistency with the time units used is estimating
activity durations. Project reports and graphs would typically use actual calendar
days.

Back to top

10.6 Critical Path Scheduling for Activity-on-Node and

with Leads, Lags, and Windows
Performing the critical path scheduling algorithm for activity-on-node
representations is only a small variation from the activity-on-branch algorithm
presented above. An example of the activity-on-node diagram for a seven activity
network is shown in Figure 10-3. Some addition terminology is needed to account
for the time delay at a node associated with the task activity. Accordingly, we
define: ES(i) as the earliest start time for activity (and node) i, EF(i) is the earliest
finish time for activity (and node) i, LS(i) is the latest start and LF(i) is the latest
finish time for activity (and node) i. Table 10-7 shows the relevant calculations for
the node numbering algorithm, the forward pass and the backward pass
calculations.

TABLE 10-7 Critical Path Scheduling Algorithms (Activity-on-Node Representation)

Activity Numbering Algorithm
Step 1: Give the starting activity number 0.
Step 2: Give the next number to any unnumbered activity whose predecessor activities
are each already numbered.
Repeat Step 2 until all activities are numbered.
Forward Pass
Step 1: Let E(0) = 0.
Step 2: For j = 1,2,3,...,n (where n is the last activity), let
ES(j) = maximum {EF(i)}
where the maximum is computed over all activities (i) that have j as their successor.

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 Step 3: EF(j) = ES(j) + Dj
Backward Pass
Step 1: Let L(n) equal the required completion time of the project.
Note: L(n) must equal or exceed E(n).
Step 2: For i = n-1, n-2, ..., 0, let
LF(i) = minimum {LS(j)}
where the minimum is computed over all activities (j) that have i as their predecessor.
Step 3: LS(i) = LF(i) - Di

For manual application of the critical path algorithm shown in Table 10-7, it is
helpful to draw a square of four entries, representing the ES(i), EF(i), LS(i) and LF
(i) as shown in Figure 10-14. During the forward pass, the boxes for ES(i) and
EF(i) are filled in. As an exercise for the reader, the seven activity network in
Figure 10-3 can be scheduled. Results should be identical to those obtained for the
activity-on-branch calculations.

Figure 10-14 ES, EF, LS and LF Display for Hand Calculation of Critical Path for
Activity-on-Node Representation

Building on the critical path scheduling calculations described in the previous

sections, some additional capabilities are useful. Desirable extensions include the
definition of allowable windows for activities and the introduction of more
complicated precedence relationships among activities. For example, a planner may
wish to have an activity of removing formwork from a new building
component follow the concrete pour by some pre-defined lag period to allow
setting. This delay would represent a required gap between the completion of a
preceding activity and the start of a successor. The scheduling calculations to
accommodate these complications will be described in this section. Again, the
standard critical path scheduling assumptions of fixed activity durations and
unlimited resource availability will be made here, although these assumptions will
be relaxed in later sections.

A capability of many scheduling programs is to incorporate types of activity

interactions in addition to the straightforward predecessor finish to successor start
constraint used in Section 10.3. Incorporation of additional categories of
interactions is often called precedence diagramming. [2] For example, it may be

360
the case that installing concrete forms in a foundation trench might begin a few
hours after the start of the trench excavation. This would be an example of a start-
to-start constraint with a lead: the start of the trench-excavation activity would lead
the start of the concrete-form-placement activity by a few hours. Eight separate
categories of precedence constraints can be defined, representing greater than
(leads) or less than (lags) time constraints for each of four different inter-activity
relationships. These relationships are summarized in Table 10-8. Typical
precedence relationships would be:

• Direct or finish-to-start leads

The successor activity cannot start until the preceding activity is complete by
at least the prescribed lead time (FS). Thus, the start of a successor activity
must exceed the finish of the preceding activity by at least FS.
• Start-to-start leads
The successor activity cannot start until work on the preceding activity has
been underway by at least the prescribed lead time (SS).
• Finish-to-finish leadss
The successor activity must have at least FF periods of work remaining at
the completion of the preceding activity.
• Start-to-finish leads
The successor activity must have at least SF periods of work remaining at
the start of the preceding activity.

While the eight precedence relationships in Table 10-8 are all possible, the most
common precedence relationship is the straightforward direct precedence between
the finish of a preceding activity and the start of the successor activity with no
required gap (so FS = 0).

TABLE 10-8 Eight Possible Activity Precedence Relationships

Relationship Explanation
Finish-to-start Lead Latest Finish of Predecessor Earliest Start of Successor + FS
Finish-to-start Lag Latest Finish of Predecessor Earliest Start of Successor + FS
Start-to-start Lead Earliest Start of Predecessor Earliest Start of Successor + SS
Start-to-start Lag Earliest Start of Predecessor Earliest Start of Successor + SS
Finish-to-finish Lead Latest Finish of Predecessor Earliest Finish of Successor + FF
Finish-to-finish Lag Latest Finish of Predecessor Earliest Finish of Successor + FF
Start-to-finish Lead Earliest Start of Predecessor Earliest Finish of Successor + SF
Start-to-finish Lag Earliest Start of Predecessor Earliest Finish of Successor + SF

The computations with these lead and lag constraints are somewhat more
complicated variations on the basic calculations defined in Table 10-1 for critical

361
path scheduling. For example, a start-to-start lead would modify the calculation of
the earliest start time to consider whether or not the necessary lead constraint was
met:

(10.12)

where SSij represents a start-to-start lead between activity (i,j) and any of the
activities starting at event j.

The possibility of interrupting or splitting activities into two work segments can be
particularly important to insure feasible schedules in the case of numerous lead or
lag constraints. With activity splitting, an activity is divided into two sub-activities
with a possible gap or idle time between work on the two subactivities. The
computations for scheduling treat each sub-activity separately after a split is made.
Splitting is performed to reflect available scheduling flexibility or to allow the
development of a feasible schedule. For example, splitting may permit scheduling
the early finish of a successor activity at a date later than the earliest start of the
successor plus its duration. In effect, the successor activity is split into two
segments with the later segment scheduled to finish after a particular time. Most
commonly, this occurs when a constraint involving the finish time of two activities
determines the required finish time of the successor. When this situation occurs, it
is advantageous to split the successor activity into two so the first part of the
successor activity can start earlier but still finish in accordance with the applicable
finish-to-finish constraint.

Finally, the definition of activity windows can be extremely useful. An activity

window defines a permissible period in which a particularly activity may be
scheduled. To impose a window constraint, a planner could specify an earliest
possible start time for an activity (WES) or a latest possible completion time
(WLF). Latest possible starts (WLS) and earliest possible finishes (WEF) might
also be imposed. In the extreme, a required start time might be insured by setting
the earliest and latest window start times equal (WES = WLS). These window
constraints would be in addition to the time constraints imposed by precedence
relationships among the various project activities. Window constraints are
particularly useful in enforcing milestone completion requirements on project
activities. For example, a milestone activity may be defined with no duration but a
latest possible completion time. Any activities preceding this milestone activity
cannot be scheduled for completion after the milestone date. Window constraints
are actually a special case of the other precedence constraints summarized above:
windows are constraints in which the precedecessor activity is the project start.
Thus, an earliest possible start time window (WES) is a start-to-start lead.

One related issue is the selection of an appropriate network representation.

Generally, the activity-on-branch representation will lead to a more compact

362
diagram and is also consistent with other engineering network representations of
structures or circuits. [3] For example, the nine activities shown in Figure 10-4
result in an activity-on-branch network with six nodes and nine branches. In
contrast, the comparable activity-on-node network shown in Figure 9-6 has eleven
nodes (with the addition of a node for project start and completion) and fifteen
branches. The activity-on-node diagram is more complicated and more difficult to
draw, particularly since branches must be drawn crossing one another. Despite this
larger size, an important practical reason to select activity-on-node diagrams is that
numerous types of precedence relationships are easier to represent in these
diagrams. For example, different symbols might be used on each of the branches in
Figure 9-6 to represent direct precedences, start-to-start precedences, start-to-finish
precedences, etc. Alternatively, the beginning and end points of the precedence
links can indicate the type of lead or lag precedence relationship. Another
advantage of activity-on-node representations is that the introduction of dummy
links as in Figure 10-1 is not required. Either representation can be used for the
critical path scheduling computations described earlier. In the absence of lead and
lag precedence relationships, it is more common to select the compact activity-on-
branch diagram, although a unified model for this purpose is described in Chapter
11. Of course, one reason to pick activity-on-branch or activity-on-node
representations is that particular computer scheduling programs available at a site
are based on one representation or the other. Since both representations are in
common use, project managers should be familiar with either network
representation.

Many commercially available computer scheduling programs include the necessary

computational procedures to incorporate windows and many of the various
precedence relationships described above. Indeed, the term "precedence
diagramming" and the calculations associated with these lags seems to have first
appeared in the user's manual for a computer scheduling program. [4]

If the construction plan suggests that such complicated lags are important, then
these scheduling algorithms should be adopted. In the next section, the various
computations associated with critical path scheduling with several types of leads,
lags and windows are presented.

Back to top

10.7 Calculations for Scheduling with Leads, Lags and

Windows
Table 10-9 contains an algorithmic description of the calculations required for
critical path scheduling with leads, lags and windows. This description assumes
an activity-on-node project network representation, since this representation is
much easier to use with complicated precedence relationships. The possible

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precedence relationships accomadated by the procedure contained in Table 10-9 are
finish-to-start leads, start-to-start leads, finish-to-finish lags and start-to-finish lags.
Windows for earliest starts or latest finishes are also accomodated. Incorporating
other precedence and window types in a scheduling procedure is also possible as
described in Chapter 11. With an activity-on-node representation, we assume that
an initiation and a termination activity are included to mark the beginning and end
of the project. The set of procedures described in Table 10-9 does not provide for
automatic splitting of activities.

TABLE 10-9 Critical Path Scheduling Algorithms with Leads, Lags and Windows (Activity-
on-Node Representations)
Activity Numbering Algorithm
Step 1: Give the starting activity number 0.
Step 2: Give the next number to any unnumbered activity whose predecessor activities
are each already numbered.
Repeat Step 2 until all activities are numbered.
Forward Pass Computations
Step 0: Set the earliest start and the earliest finish of the initial activity to zero:
(ES(0) = EF(0) = 0).
Repeat the following steps for each activity k = 0,1,2,...,m:
Step 1: Compute the earliest start time (ES(k)) of activity k:
ES(k) = Maximum {0; WES(k) for the earliest start window time,
WEF(k) - D(k) for the earliest finish window time;
EF(i) + FS(i,k) for each preceding activity with a F-S constraint;
ES(i) + SS(i,k) for each preceding activity with a S-S constraint;
EF(i) + FF(i,k) - D(k) for each preceding activity with a F-F constraint;
ES(i) + SF(i,k) - D(k) for each preceding activity with a S-F constraint.}
Step 2: Compute the earliest finish time EF(k) of activity k:
EF(k) = ES(k) + D(k).
Backward Pass Computations
Step 0: Set the latest finish and latest start of the terminal activity to the early start time:
LF(m) = LS(m) = ES(m) = EF(m)
Repeat the following steps for each activity in reverse order, k = m-1,m-2,...,2,1,0: Step 1:
Compute the latest finish time for activity k:
LF(k) = Min{ LF(m), WLF(k) for the latest finish window time;
WLS(k) + D(k) for the latest start window time;
LS(j) - FS(k,j) for each succeeding activity with a F-S constraint;
LF(j) - FF(k,j) for each succeeding activity with a FF constraint;
LS(j) - SS(k,j) + D(k) for each succeeding activity with a SS constraint;
LF(j) - SF(k,j) + D(k) for each succeeding activity with a SF constraint.}
Step 2: Compute the latest start time for activity k:
LS(k) = LF(k) - D(k)

The first step in the scheduling algorithm is to sort activities such that no higher
numbered activity precedes a lower numbered activity. With numbered activities,
durations can be denoted D(k), where k is the number of an activity. Other activity

364
information can also be referenced by the activity number. Note that node events
used in activity-on-branch representations are not required in this case.

The forward pass calculations compute an earliest start time (ES(k)) and an earliest
finish time (EF(k)) for each activity in turn (Table 10-9). In computing the earliest
start time of an activity k, the earliest start window time (WES), the earliest finish
window time (WEF), and each of the various precedence relationships must be
considered. Constraints on finish times are included by identifying minimum finish
times and then subtracting the activity duration. A default earliest start time of day
0 is also insured for all activities. A second step in the procedure is to identify each
activity's earliest finish time (EF(k)).

The backward pass calculations proceed in a manner very similar to those of the
forward pass (Table 10-9). In the backward pass, the latest finish and the latest start
times for each activity are calculated. In computing the latest finish time, the latest
start time is identified which is consistent with precedence constraints on an
activity's starting time. This computation requires a minimization over applicable
window times and all successor activities. A check for a feasible activity schedule
can also be imposed at this point: if the late start time is less than the early start
time (LS(k) < ES(k)), then the activity schedule is not possible.

The result of the forward and backward pass calculations are the earliest start time,
the latest start time, the earliest finish time, and the latest finish time for each
activity. The activity float is computed as the latest start time less the earliest start
time. Note that window constraints may be instrumental in setting the amount of
float, so that activities without any float may either lie on the critical path or be
constrained by an allowable window.

To consider the possibility of activity splitting, the various formulas for the forward
and backward passes in Table 10-9 must be modified. For example, in considering
the possibility of activity splitting due to start-to-start lead (SS), it is important to
ensure that the preceding activity has been underway for at least the required lead
period. If the preceding activity was split and the first sub-activity was not
underway for a sufficiently long period, then the following activity cannot start
until the first plus the second sub-activities have been underway for a period equal
to SS(i,k). Thus, in setting the earliest start time for an activity, the calculation
takes into account the duration of the first subactivity (DA(i)) for preceding
activities involving a start-to-start lead. Algebraically, the term in the earliest start
time calculation pertaining to start-to-start precedence constraints (ES(i) + SS(i,k))
has two parts with the possibility of activity splitting:

(10.13) ES(i) + SS(i,k)

(10.14) EF(i) - D(i) + SS(i,k) for split preceding activities with DA(i) < SS(i,k)

where DA(i) is the duration of the first sub-activity of the preceding activity.

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The computation of earliest finish time involves similar considerations, except that
the finish-to-finish and start-to-finish lag constraints are involved. In this case, a
maximization over the following terms is required:

EF(k) = Maximum{ES(k) + D(k),

EF(i) + FF(i,k) for each preceding activity with a FF precedence,
ES(i) + SF(i,k) for each preceding activity with a SF precedence and
(10.15)
which is not split,
EF(i) - D(i) + SF(i,k) for each preceding activity with a SF
precedence and which is split}

Finally, the necessity to split an activity is also considered. If the earliest possible
finish time is greater than the earliest start time plus the activity duration, then the
activity must be split.

Another possible extension of the scheduling computations in Table 10-9 would be

to include a duration modification capability during the forward and backward
passes. This capability would permit alternative work calendars for different
activities or for modifications to reflect effects of time of the year on activity
durations. For example, the duration of outside work during winter months would
be increased. As another example, activities with weekend work permitted might
have their weekday durations shortened to reflect weekend work accomplishments.

Example 10-4: Impacts of precedence relationships and windows

To illustrate the impacts of different precedence relationships, consider a project

consisting of only two activities in addition to the start and finish. The start is
numbered activity 0, the first activity is number 1, the second activity is number 2,
and the finish is activity 3. Each activity is assumed to have a duration of five days.
With a direct finish-to-start precedence relationship without a lag, the critical path
calculations reveal:
ES(0) = 0
ES(1) = 0
EF(1) = ES(1) + D(1) = 0 + 5 = 5
ES(2) = EF(1) + FS(1,2) = 5 + 0 = 5
EF(2) = ES(2) + D(2) = 5 + 5 = 10
ES(3) = EF(2) + FS(2,3) = 10 + 0 = 10 = EF(3)

So the earliest project completion time is ten days.

With a start-to-start precedence constraint with a two day lead, the scheduling
calculations are:

ES(0) = 0
ES(1) = 0
EF(1) = ES(1) + D(1) = 0 + 5 = 5

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ES(2) = ES(1) + SS(1,2) = 0 + 2 = 2
EF(2) = ES(2) + D(2) = 2 + 5 = 7
ES(3) = EF(2) + FS(2,3) = 7 + 0 = 7.

In this case, activity 2 can begin two days after the start of activity 1 and proceed in
parallel with activity 1. The result is that the project completion date drops from ten
days to seven days.

Finally, suppose that a finish-to-finish precedence relationship exists between

activity 1 and activity 2 with a two day lag. The scheduling calculations are:

ES(0) = 0 = EF(0)
ES(1) = EF(0) + FS(0,1) = 0 + 0 = 0
EF(1) = ES(1) + D(1) = 0 + 5 = 5
ES(2) = EF(1) + FF(1,2) - D(2) = 5 + 2 - 5 = 2
EF(2) = ES(2) + D(2) = 2 + 5 = 7
ES(3) = EF(2) + FS(2,3) = 7 + 0 = 7 = EF(3)

In this case, the earliest finish for activity 2 is on day seven to allow the necessary
two day lag from the completion of activity 1. The minimum project completion
time is again seven days.

Example 10-5: Scheduling in the presence of leads and windows.

As a second example of the scheduling computations involved in the presence of

leads, lags and windows, we shall perform the calculations required for the project
shown in Figure 10-15. Start and end activities are included in the project diagram,
making a total of eleven activities. The various windows and durations for the
activities are summarized in Table 10-10 and the precedence relationships appear in
Table 10-11. Only earliest start (WES) and latest finish (WLF) window constraints
are included in this example problem. All four types of precedence relationships are
included in this project. Note that two activities may have more than one type of
precedence relationship at the same time; in this case, activities 2 and 5 have both
S-S and F-F precedences. In Figure 10-15, the different precedence relationships
are shown by links connecting the activity nodes. The type of precedence
relationship is indicated by the beginning or end point of each arrow. For example,
start-to-start precedences go from the left portion of the preceding activity to the
left portion of the following activity. Application of the activity sorting algorithm
(Table 10-9) reveals that the existing activity numbers are appropriate for the
critical path algorithm. These activity numbers will be used in the forward and
backward pass calculations.

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Figure 10-15 Example Project Network with Lead Precedences

TABLE 10-10 Predecessors, Successors, Windows and Durations for an Example Project
Activity Earliest Start Latest Finish Activity
Number Predecessors Successors Window Window Duration
0 --- 1, 2, 4 --- --- 0
1 0 3, 4, 6 --- --- 2
2 0 5 --- --- 5
3 1 6 2 --- 4
4 0 7, 8 --- --- 3
5 2, 2 7, 8 --- 16 5
6 1, 39 6 16 6
7 4, 59 --- --- 2
8 4, 5 10 --- --- 4
9 6, 7 10 --- 16 5
10 8, 9 --- --- --- 0

TABLE 10-11 Precedences in a Eleven Activity Project Example

Predecessor Successor Type Lead
0 1 FS 0
0 2 FS 0
0 4 FS 0
1 3 SS 1
1 4 SF 1
1 6 FS 2

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 2 5 SS 2
2 5 FF 2
3 6 FS 0
4 7 SS 2
4 8 FS 0
5 7 FS 1
5 8 SS 3
6 9 FF 4
7 9 FS 0
8 10 FS 0
9 10 FS 0

During the forward pass calculations (Table 10-9), the earliest start and earliest
finish times are computed for each activity. The relevant calculations are:

ES(0) = EF(0) = 0
ES(1) = Max{0; EF(0) + FS(0,1)} = Max {0; 0 + 0} = 0.
EF(1) = ES(1) + D(1) = 0 + 2 = 2
ES(2) = Max{0; EF(0) + FS(0,1)} = Max{0; 0 + 0} = 0.
EF(2) = ES(2) + D(2) = 0 + 5 = 5
ES(3) = Max{0; WES(3); ES(1) + SS(1,3)} = Max{0; 2; 0 + 1} = 2.
EF(3) = ES(3) + D(3) = 2 + 4 = 6

Note that in the calculation of the earliest start for activity 3, the start was delayed
to be consistent with the earliest start time window.

ES(4) = Max{0; ES(0) + FS(0,1); ES(1) + SF(1,4) - D(4)} = Max{0; 0 + 0; 0+1-3}

= 0.
EF(4) = ES(4) + D(4) = 0 + 3 = 3
ES(5) = Max{0; ES(2) + SS(2,5); EF(2) + FF(2,5) - D(5)} = Max{0; 0+2; 5+2-5} =
2
EF(5) = ES(5) + D(5) = 2 + 5 = 7
ES(6) = Max{0; WES(6); EF(1) + FS(1,6); EF(3) + FS(3,6)} = Max{0; 6; 2+2;
6+0} = 6
EF(6) = ES(6) + D(6) = 6 + 6 = 12
ES(7) = Max{0; ES(4) + SS(4,7); EF(5) + FS(5,7)} = Max{0; 0+2; 7+1} = 8
EF(7) = ES(7) + D(7) = 8 + 2 = 10
ES(8) = Max{0; EF(4) + FS(4,8); ES(5) + SS(5,8)} = Max{0; 3+0; 2+3} = 5
EF(8) = ES(8) + D(8) = 5 + 4 = 9
ES(9) = Max{0; EF(7) + FS(7,9); EF(6) + FF(6,9) - D(9)} = Max{0; 10+0; 12+4-
5} = 11
EF(9) = ES(9) + D(9) = 11 + 5 = 16
ES(10) = Max{0; EF(8) + FS(8,10); EF(9) + FS(9,10)} = Max{0; 9+0; 16+0} = 16
EF(10) = ES(10) + D(10) = 16

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As the result of these computations, the earliest project completion time is found to
be 16 days.

The backward pass computations result in the latest finish and latest start times for
each activity. These calculations are:

LF(10) = LS(10) = ES(10) = EF(10) = 16

LF(9) = Min{WLF(9); LF(10);LS(10) - FS(9,10)} = Min{16;16; 16-0} = 16
LS(9) = LF(9) - D(9) = 16 - 5 = 11
LF(8) = Min{LF(10); LS(10) - FS(8,10)} = Min{16; 16-0} = 16
LS(8) = LF(8) - D(8) = 16 - 4 = 12
LF(7) = Min{LF(10); LS(9) - FS(7,9)} = Min{16; 11-0} = 11
LS(7) = LF(7) - D(7) = 11 - 2 = 9
LF(6) = Min{LF(10); WLF(6); LF(9) - FF(6,9)} = Min{16; 16; 16-4} = 12
LS(6) = LF(6) - D(6) = 12 - 6 = 6
LF(5) = Min{LF(10); WLF(10); LS(7) - FS(5,7); LS(8) - SS(5,8) + D(8)} =
Min{16; 16; 9-1; 12-3+4} = 8
LS(5) = LF(5) - D(5) = 8 - 5 = 3
LF(4) = Min{LF(10); LS(8) - FS(4,8); LS(7) - SS(4,7) + D(7)} = Min{16; 12-0; 9-
2+2} = 9
LS(4) = LF(4) - D(4) = 9 - 3 = 6
LF(3) = Min{LF(10); LS(6) - FS(3,6)} = Min{16; 6-0} = 6
LS(3) = LF(3) - D(3) = 6 - 4 = 2
LF(2) = Min{LF(10); LF(5) - FF(2,5); LS(5) - SS(2,5) + D(5)} = Min{16; 8-2; 3-
2+5} = 6
LS(2) = LF(2) - D(2) = 6 - 5 = 1
LF(1) = Min{LF(10); LS(6) - FS(1,6); LS(3) - SS(1,3) + D(3); Lf(4) - SF(1,4) +
D(4)}
LS(1) = LF(1) - D(1) = 2 -2 = 0
LF(0) = Min{LF(10); LS(1) - FS(0,1); LS(2) - FS(0,2); LS(4) - FS(0,4)} = Min{16;
0-0; 1-0; 6-0} = 0
LS(0) = LF(0) - D(0) = 0

The earliest and latest start times for each of the activities are summarized in Table
10-12. Activities without float are 0, 1, 6, 9 and 10. These activities also constitute
the critical path in the project. Note that activities 6 and 9 are related by a finish-to-
finish precedence with a 4 day lag. Decreasing this lag would result in a reduction
in the overall project duration.

TABLE 10-12 Summary of Activity Start and Finish Times for an Example Problem
Activity Earliest Start Latest Start Float
0 0 0 0
1 0 0 0
2 0 1 1
3 0 2 2

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 4 0 6 6
5 2 3 1
6 6 6 0
7 8 9 1
8 5 12 7
9 11 11 0
10 16 16 0

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10.8 Resource Oriented Scheduling

Resource constrained scheduling should be applied whenever there are limited
resources available for a project and the competition for these resources among the
project activities is keen. In effect, delays are liable to occur in such cases as
activities must wait until common resources become available. To the extent that
resources are limited and demand for the resource is high, this waiting may be
considerable. In turn, the congestion associated with these waits represents
increased costs, poor productivity and, in the end, project delays. Schedules made
without consideration for such bottlenecks can be completely unrealistic.

Resource constrained scheduling is of particular importance in managing multiple

projects with fixed resources of staff or equipment. For example, a design office
has an identifiable staff which must be assigned to particular projects and design
activities. When the workload is heavy, the designers may fall behind on
completing their assignments. Government agencies are particularly prone to the
problems of fixed staffing levels, although some flexibility in accomplishing tasks
is possible through the mechanism of contracting work to outside firms.
Construction activities are less susceptible to this type of problem since it is easier
and less costly to hire additional personnel for the (relatively) short duration of a
construction project. Overtime or double shift work also provide some flexibility.

Resource oriented scheduling also is appropriate in cases in which unique resources

are to be used. For example, scheduling excavation operations when one only
excavator is available is simply a process of assigning work tasks or job segments
on a day by day basis while insuring that appropriate precedence relationships are
maintained. Even with more than one resource, this manual assignment process
may be quite adequate. However, a planner should be careful to insure that
necessary precedences are maintained.

Resource constrained scheduling represents a considerable challenge and source of

frustration to researchers in mathematics and operations research. While algorithms
for optimal solution of the resource constrained problem exist, they are generally
too computationally expensive to be practical for all but small networks (of less

371
than about 100 nodes). [5] The difficulty of the resource constrained project
scheduling problem arises from the combinatorial explosion of different resource
assignments which can be made and the fact that the decision variables are integer
values representing all-or-nothing assignments of a particular resource to a
particular activity. In contrast, simple critical path scheduling deals with continuous
time variables. Construction projects typically involve many activities, so optimal
solution techniques for resource allocation are not practical.

One possible simplification of the resource oriented scheduling problem is to

ignore precedence relationships. In some applications, it may be impossible or
unnecessary to consider precedence constraints among activities. In these cases, the
focus of scheduling is usually on efficient utilization of project resources. To insure
minimum cost and delay, a project manager attempts to minimize the amount of
time that resources are unused and to minimize the waiting time for scarce
resources. This resource oriented scheduling is often formalized as a problem of
"job shop" scheduling in which numerous tasks are to be scheduled for completion
and a variety of discrete resources need to perform operations to complete the tasks.
Reflecting the original orientation towards manufacturing applications, tasks are
usually referred to as "jobs" and resources to be scheduled are designated
"machines." In the provision of constructed facilities, an analogy would be an
architectural/engineering design office in which numerous design related tasks are
to be accomplished by individual professionals in different departments. The
scheduling problem is to insure efficient use of the individual professionals (i.e. the
resources) and to complete specific tasks in a timely manner.

The simplest form of resource oriented scheduling is a reservation system for

particular resources. In this case, competing activities or users of a resource pre-
arrange use of the resource for a particular time period. Since the resource
assignment is known in advance, other users of the resource can schedule their
activities more effectively. The result is less waiting or "queuing" for a resource. It
is also possible to inaugurate a preference system within the reservation process so
that high-priority activities can be accomadated directly.

In the more general case of multiple resources and specialized tasks, practical
resource constrained scheduling procedures rely on heuristic procedures to develop
good but not necessarily optimal schedules. While this is the occasion for
considerable anguish among researchers, the heuristic methods will typically give
fairly good results. An example heuristic method is provided in the next section.
Manual methods in which a human scheduler revises a critical path schedule in
light of resource constraints can also work relatively well. Given that much of the
data and the network representation used in forming a project schedule are
uncertain, the results of applying heuristic procedures may be quite adequate in
practice.

Example 10-6: A Reservation System [6]

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A recent construction project for a high-rise building complex in New York City
was severely limited in the space available for staging materials for hauling up the
building. On the four building site, thirty-eight separate cranes and elevators were
available, but the number of movements of men, materials and equipment was
expected to keep the equipment very busy. With numerous sub-contractors desiring
the use of this equipment, the potential for delays and waiting in the limited staging
area was considerable. By implementing a crane reservation system, these problems
were nearly entirely avoided. The reservation system required contractors to
telephone one or more days in advance to reserve time on a particular crane. Time
were available on a first-come, first-served basis (i.e. first call, first choice of
available slots). Penalties were imposed for making an unused reservation. The
reservation system was also computerized to permit rapid modification and
updating of information as well as the provision of standard reservation schedules
to be distributed to all participants.

Example 10-7: Heuristic Resource Allocation

Suppose that a project manager has eleven pipe sections for which necessary
support structures and materials are available in a particular week. To work on
these eleven pipe sections, five crews are available. The allocation problem is to
assign the crews to the eleven pipe sections. This allocation would consist of a list
of pipe sections allocated to each crew for work plus a recommendation on the
appropriate sequence to undertake the work. The project manager might make
assignments to minimize completion time, to insure continuous work on the
pipeline (so that one section on a pipeline run is not left incomplete), to reduce
travel time between pipe sections, to avoid congestion among the different crews,
and to balance the workload among the crews. Numerous trial solutions could be
rapidly generated, especially with the aid of an electronic spreadsheet. For example,
if the nine sections had estimated work durations for each of the fire crews as
shown in Table 10-13, then the allocations shown in Figure 10-16 would result in a
minimum completion time.
TABLE 10-13 Estimated Required Time for Each Work Task in a Resource Allocation
Problem
Section Work Duration
A 9
B 9
C 8
D 8
E 7
F 7
G 6
H 6
I 6
J 5
K 5

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Figure 10-16 Example Allocation of Crews to Work Tasks

Example 10-8: Algorithms for Resource Allocation with Bottleneck Resources

In the previous example, suppose that a mathematical model and solution was
desired. For this purpose, we define a binary (i.e. 0 or 1 valued) decision variable
for each pipe section and crew, xij, where xij = 1 implies that section i was assigned
to crew j and xij = 0 implied that section i was not assigned to crew j. The time
required to complete each section is ti. The overall time to complete the nine
sections is denoted z. In this case, the problem of minimizing overall completion
time is:

subject to the constraints:

for each section i

xij is 0 or 1

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where the constraints simply insure that each section is assigned to one and only
one crew. A modification permits a more conventional mathematical formulation,
resulting in a generalized bottleneck assignment problem:

Minimize z
subject to the constraints:

for each crew j

for each section i

xij is 0 or 1

This problem can be solved as an integer programming problem, although at

considerable computational expense. A common extension to this problem would
occur with differential productivities for each crew, so that the time to complete an
activity, tij, would be defined for each crew. Another modification to this problem
would substitute a cost factor, cj, for the time factor, tj, and attempt to minimize
overall costs rather than completion time.

Back to top

10.9 Scheduling with Resource Constraints and

Precedences
The previous section outlined resource oriented approaches to the scheduling
problem. In this section, we shall review some general approaches to integrating
both concerns in scheduling.

Two problems arise in developing a resource constrained project schedule. First, it

is not necessarily the case that a critical path schedule is feasible. Because one or
more resources might be needed by numerous activities, it can easily be the case
that the shortest project duration identified by the critical path scheduling
calculation is impossible. The difficulty arises because critical path scheduling
assumes that no resource availability problems or bottlenecks will arise. Finding a
feasible or possible schedule is the first problem in resource constrained
scheduling. Of course, there may be a numerous possible schedules which conform
with time and resource constraints. As a second problem, it is also desirable to
determine schedules which have low costs or, ideally, the lowest cost.

Numerous heuristic methods have been suggested for resource constrained

scheduling. Many begin from critical path schedules which are modified in light of
the resource constraints. Others begin in the opposite fashion by introducing
resource constraints and then imposing precedence constraints on the activities.

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Still others begin with a ranking or classification of activities into priority groups
for special attention in scheduling. [7] One type of heuristic may be better than
another for different types of problems. Certainly, projects in which only an
occasional resource constraint exists might be best scheduled starting from a
critical path schedule. At the other extreme, projects with numerous important
resource constraints might be best scheduled by considering critical resources first.
A mixed approach would be to proceed simultaneously considering precedence and
resource constraints.

A simple modification to critical path scheduling has been shown to be effective for
a number of scheduling problems and is simple to implement. For this heuristic
procedure, critical path scheduling is applied initially. The result is the familiar set
of possible early and late start times for each activity. Scheduling each activity to
begin at its earliest possible start time may result in more than one activity
requiring a particular resource at the same time. Hence, the initial schedule may not
be feasible. The heuristic proceeds by identifying cases in which activities compete
for a resource and selecting one activity to proceed. The start time of other
activities are then shifted later in time. A simple rule for choosing which activity
has priority is to select the activity with the earliest CPM late start time (calculated
as LS(i,j) = L(j)-Dij) among those activities which are both feasible (in that all their
precedence requirements are satisfied) and competing for the resource. This
decision rule is applied from the start of the project until the end for each type of
resource in turn.

The order in which resources are considered in this scheduling process may
influence the ultimate schedule. A good heuristic to employ in deciding the order in
which resources are to be considered is to consider more important resources first.
More important resources are those that have high costs or that are likely to
represent an important bottleneck for project completion. Once important resources
are scheduled, other resource allocations tend to be much easier. The resulting
scheduling procedure is described in Table 10-14.

The late start time heuristic described in Table 10-14 is only one of many possible
scheduling rules. It has the advantage of giving priority to activities which must
start sooner to finish the project on time. However, it ismyopic in that it doesn't
consider trade-offs among resource types nor the changes in the late start time that
will be occurring as activities are shifted later in time. More complicated rules can
be devised to incorporate broader knowledge of the project schedule. These
complicated rules require greater computational effort and may or may not result in
scheduling improvements in the end.

TABLE 10-14 A Resource-Oriented Scheduling Procedure

Step 1:
Rank all resources from the most important to the least important,
and number the resources i = 1,2,3,...,m.

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 Step 2:
Set the scheduled start time for each activity to the earliest start time.

For each resource i = 1,2,3,...,m in turn:

Step 3:
Start at the project beginning, so set t = 0.
Step 4:
Compute the demand for resource i at time t by summing up the
requirements for resource i for all activities scheduled to be
underway at time t.

If demand for resource i in time t is greater than the resource availability,

then select the activity with the greatest late start time requiring resource i at
time t, and shift its scheduled start time to time t+1.

Repeat Step 4 until the resource constraint at time t for resource i is

satisfied.

Step 5:
Repeat step 4 for each project period in turn, setting t = t+1.

Example 10-9: Resource constrained scheduling with nine activities.

As an example of resource constrained scheduling, we shall re-examine the nine

activity project discussed in Section 10.3. To begin with, suppose that four workers
and two pieces of equipment such as backhoes are available for the project. The
required resources for each of the nine project activities are summarized in Table
10-15. Graphs of resource requirements over the 30 day project duration are shown
in Figure 10-17. Equipment availability in this schedule is not a problem. However,
on two occasions, more than the four available workers are scheduled for work.
Thus, the existing project schedule is infeasible and should be altered.
TABLE 10-15 Resources Required and Starting Times for a Nine Activity Project
Workers Equipment Earliest Start Latest Start
Activity Required Required Time Time Duration
A 2 0 0 0 4
B 2 1 0 9 3
C 2 1 4 4 8
D 2 1 4 15 7
E 2 1 12 13 9
F 2 0 12 12 12
G 2 1 21 22 2
H 2 1 21 25 5
I 4 1 24 24 6

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Figure 10-17 Resources Required over Time for Nine Activity Project: Schedule I

The first resource problem occurs on day 21 when activity F is underway and
activities G and H are scheduled to start. Applying the latest start time heuristic to
decide which activity should start, the manager should re-schedule activity H since
it has a later value of LS(i,j), i.e., day 25 versus day 22 as seen in Table 10-15. Two
workers become available on day 23 after the completion of activity G. Since
activity H is the only activity which is feasible at that time, it is scheduled to begin.
Two workers also become available on day 24 at the completion of activity F. At

378
this point, activity I is available for starting. If possible, it would be scheduled to
begin with only two workers until the completion of activity H on day 28. If all 4
workers were definitely required, then activity I would be scheduled to begin on
day 28. In this latter case, the project duration would be 34 days, representing a 4
day increase due to the limited number of workers available.

Example 10-10: Additional resource constraints.

As another example, suppose that only one piece of equipment was available for
the project. As seen in Figure 10-17, the original schedule would have to be
significantly modified in this case. Application of the resource constrained
scheduling heuristic proceeds as follows as applied to the original project schedule:

1. On day 4, activities D and C are both scheduled to begin. Since activity D

has a larger value of late start time, it should be re-scheduled.
2. On day 12, activities D and E are available for starting. Again based on a
later value of late start time (15 versus 13), activity D is deferred.
3. On day 21, activity E is completed. At this point, activity D is the only
feasible activity and it is scheduled for starting.
4. On day 28, the planner can start either activity G or activity H. Based on the
later start time heuristic, activity G is chosen to start.
5. On completion of activity G at day 30, activity H is scheduled to begin.

The resulting profile of resource use is shown in Figure 10-18. Note that activities
F and I were not considered in applying the heuristic since these activities did not
require the special equipment being considered. In the figure, activity I is scheduled
after the completion of activity H due to the requirement of 4 workers for this
activity. As a result, the project duration has increased to 41 days. During much of
this time, all four workers are not assigned to an activity. At this point, a prudent
planner would consider whether or not it would be cost effective to obtain an
additional piece of equipment for the project.

379
Figure 10-18 Resources Required over Time for Nine Activity Project: Schedule
II

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10.10 References
1. Au, T. Introduction to Systems Engineering--Deterministic Models,
Addison-Wesley, Reading, MA, 1973, Chapter 8.
2. Baker, K., An Introduction to Sequencing and Scheduling, John Wiley, 1974.
3. Jackson, M.J., Computers in Construction Planning and Control, Allen &
Unwin, 1986.
4. Moder, J., C. Phillips and E. Davis, Project Management with CPM, PERT
and Precedence Diagramming, Van Nostrand Reinhold Company, Third
Edition,1983.
5. Willis, E. M., Scheduling Construction Projects, John Wiley & Sons, 1986.

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380
10.11 Problems
1 to 4.
Construct an activity-on-branch network from the precedence relationships
of activities in the project given in the table for the problem, Tables 10-16 to
10-19.

TABLE 10-16
Activity A B C D E F G HI J K L M N O
Predecessors --- A A --- B C,D C,D D H F E,J F G,I G,I L,N
Duration 6 7 1 14 5 8 9 3 5 3 4 12 6 2 7
TABLE 10-17
Activity A B CDE F G H I J K L MN
Predecessors --- A B C D,G A F,J --- H I F,J H L K,M
Duration 5 6 3 4 5 8 3 3 2 72 7 4 3
TABLE 10-18
Activity A B C DE F G H I J K L
Predecessors --- --- --- A B C B,D C,E F F E,G,I H,J
Duration 6 12 16 5 3 10 9 4 5 3 10 6
TABLE 10-19
Activity A B C DE F G H I J K L M
Predecessors --- --- --- C C B,E A,F B,E B,E B,E D,J G,H I,K,L
Duration 3 6 2 3 8 5 7 10 6 6 8 3 4
5 to 8.
Determine the critical path and all slacks for the projects in Tables 10-16 to
10-19.

9. Suppose that the precedence relationships for Problem 1 in Table 10-16 are
all direct finish-to-start relationships with no lags except for the following:
o B to E: S-S with a lag of 2.
o D to H: F-F with a lag of 3.
o F to L: S-S with a lag of 2.
o G to N: S-S with a lag of 1.
o G to M: S-S with a lag of 2.

Formulate an activity-on-node network representation and recompute the

critical path with these precedence relationships.

381
 10.Suppose that the precedence relationships for Problem 2 in Table 10-17 are
all direct finish-to-start relationships with no lags except for the following:
o C to D: S-S with a lag of 1
o D to E: F-F with a lag of 3
o A to F: S-S with a lag of 2
o H to I: F-F with a lag of 4
o L to M: S-S with a lag of 1

Formulate an activity-on-node network representation and recompute the

critical path with these precedence relationships.

11 to 12.
For the projects described in Tables 10-20 and 10-21, respectively, suggest a
project schedule that would complete the project in minimum time and result
in relatively constant or level requirements for labor over the course of the
project.

TABLE 10-20
Activity A B C D E F G H I J K
Predecessors --- --- --- A B B C C D,E F,G H
Duration 3 5 1 1 7 6 4 3 6 4 3
Workers Per Day 9 6 4 10 16 9 5 8 2 3 7
TABLE 10-21
Activity A B C D E F G H I J K L M N
Predecessors --- --- --- A A A B B C F,G H,I,L F,G D,J E,K
Duration 5 1 7 2 6 4 3 2 6 4 5 1 4 5
Workers Per Day 0 3 0 9 5 4 2 14 10 4 1 2 7 3

13.Develop a spreadsheet template that lists activity name, duration, required

resources, earliest possible start, latest possible start, and scheduled start in
separate columns for a maximum of twenty activities. By means of formulas,
also develop the required resources for each day of the project, based on the
activities' scheduled start, expected durations, and required resources. Use
the spreadsheet graphics facility to plot the required resources over time. Use
your template to solve Problems 11 and 12 by altering scheduled start times.
(Hint: One way to prepare such a template is to use a column to represent a
single day with each cell in the column indicating resources required by a
particular activity on the particular day).

14.Develop an example of a project network with three critical paths.

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 15.For the project defined in Table 10-20, suppose that you are limited to a
maximum of 20 workers at any given time. Determine a desirable schedule
for the project, using the late start time heuristic described in Section 10.9.

16.For the project defined in Table 10-21, suppose that you are limited to a
maximum of 15 workers at any given time. Determine a desirable schedule
for the project, using the late start time heuristic described in Section 10.9.

17.The examples and problems presented in this chapter generally make use of
activity duration and project durations as measured in working days from the
beginning of the project. Outline the procedures by which time measured in
working days would be converted into calendar days with single- or double-
shift work. Could your procedure be modified to allow some but not all
activities to be underway on weekends?

Back to top

10.12 Footnotes
1. See Au, T., Introduction to Systems Engineering, Deterministic Models,
Addison-Wesley Publishing Company, Reading, MA, 1973, for a detailed
description of linear programming as a form of mathematical optimization. Back

2. See K.C. Crandall, "Project Planning with Precedence Lead/Lag

Factors," Project Management Quarterly, Vol. 4, No. 3, Sept. 1973, pp. 18-27, or
J.J. Moder, C.R. Phillips, and E.W. Davis, Project Management with CPM, PERT
and Precedence Diagramming, New York: Van Nostrand Reinhold Company, third
edition, 1983, chapter 4. Back

3. See C.T. Hendrickson and B.N. Janson, "A Common Network Formulation of
Several Civil Engineering Problems," Civil Engineering Systems, Vol. 1, No. 4,
1984, pp. 195-203. Back

4. See IBM, Project Management System, Application Description Manual, (H20-

0210), IBM, 1968. Back

5. A variety of mathematical programming techniques have been proposed for this

problem. For a review and comparison, see J.H. Patterson, "A Comparison of Exact

383
Approaches for Solving the Multiple Constrained Resource Project Scheduling
Problem," Management Science, Vol. 30, No. 7, 1984, pp. 854-867. Back

6. This example is adapted from H. Smallowitz, "Construction by Computer," Civil

Engineering, June, 1986, pp. 71-73. Back

7. For discussions and comparisons of alternative heuristic algorithms, see E.M.

Davies, "An experimental investigation of resource allocation in multiactivity
projects," Operational Research Quarterly Vol. 24, No. 11, July 1976, pp. 1186-
1194; J.D. Wiest and F.K. Levy, A Management Guide to PERT/CPM, Prentice-
Hall, New Jersey, 1977; or S.R. Lawrence, A Computational Comparison of
Heuristic Scheduling Techniques,Technical Report, Graduate School of Industrial
Administration, Carnegie-Mellon University, 1985. Back

384
11. Advanced Scheduling Techniques
11.1 Use of Advanced Scheduling Techniques
Construction project scheduling is a topic that has received extensive research over
a number of decades. The previous chapter described the fundamental scheduling
techniques widely used and supported by numerous commercial scheduling
systems. A variety of special techniques have also been developed to address
specific circumstances or problems. With the availability of more powerful
computers and software, the use of advanced scheduling techniques is becoming
easier and of greater relevance to practice. In this chapter, we survey some of the
techniques that can be employed in this regard. These techniques address some
important practical problems, such as:

• scheduling in the face of uncertain estimates on activity durations,

• integrated planning of scheduling and resource allocation,
• scheduling in unstructured or poorly formulated circumstances.

A final section in the chapter describes some possible improvements in the project
scheduling process. In Chapter 14, we consider issues of computer based
implementation of scheduling procedures, particularly in the context of integrating
scheduling with other project management procedures.

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11.2 Scheduling with Uncertain Durations

Section 10.3 described the application of critical path scheduling for the situation
in which activity durations are fixed and known. Unfortunately, activity durations
are estimates of the actual time required, and there is liable to be a significant
amount of uncertainty associated with the actual durations. During the preliminary
planning stages for a project, the uncertainty in activity durations is particularly
large since the scope and obstacles to the project are still undefined. Activities that
are outside of the control of the owner are likely to be more uncertain. For example,
the time required to gain regulatory approval for projects may vary tremendously.
Other external events such as adverse weather, trench collapses, or labor strikes
make duration estimates particularly uncertain.

Two simple approaches to dealing with the uncertainty in activity durations warrant
some discussion before introducing more formal scheduling procedures to deal
with uncertainty. First, the uncertainty in activity durations may simply be ignored
and scheduling done using the expected or most likely time duration for each
activity. Since only one duration estimate needs to be made for each activity, this

385
approach reduces the required work in setting up the original schedule. Formal
methods of introducing uncertainty into the scheduling process require more work
and assumptions. While this simple approach might be defended, it has two
drawbacks. First, the use of expected activity durations typically results in overly
optimistic schedules for completion; a numerical example of this optimism appears
below. Second, the use of single activity durations often produces a rigid, inflexible
mindset on the part of schedulers. As field managers appreciate, activity durations
vary considerable and can be influenced by good leadership and close attention. As
a result, field managers may loose confidence in the realism of a schedule based
upon fixed activity durations. Clearly, the use of fixed activity durations in setting
up a schedule makes a continual process of monitoring and updating the schedule
in light of actual experience imperative. Otherwise, the project schedule is rapidly
outdated.

A second simple approach to incorporation uncertainty also deserves mention.

Many managers recognize that the use of expected durations may result in overly
optimistic schedules, so they include a contingency allowance in their estimate of
activity durations. For example, an activity with an expected duration of two days
might be scheduled for a period of 2.2 days, including a ten percent contingency.
Systematic application of this contingency would result in a ten percent increase in
the expected time to complete the project. While the use of this rule-of-thumb
or heuristic contingency factor can result in more accurate schedules, it is likely
that formal scheduling methods that incorporate uncertainty more formally are
useful as a means of obtaining greater accuracy or in understanding the effects of
activity delays.

The most common formal approach to incorporate uncertainty in the scheduling

process is to apply the critical path scheduling process (as described in Section
10.3) and then analyze the results from a probabilistic perspective. This process is
usually referred to as the PERT scheduling or evaluation method. [1] As noted
earlier, the duration of the critical path represents the minimum time required to
complete the project. Using expected activity durations and critical path
scheduling, a critical path of activities can be identified. This critical path is then
used to analyze the duration of the project incorporating the uncertainty of the
activity durations along the critical path. The expected project duration is equal to
the sum of the expected durations of the activities along the critical path. Assuming
that activity durations are independent random variables, the variance or variation
in the duration of this critical path is calculated as the sum of the variances along
the critical path. With the mean and variance of the identified critical path known,
the distribution of activity durations can also be computed.

The mean and variance for each activity duration are typically computed from
estimates of "optimistic" (ai,j), "most likely" (mi,j), and "pessimistic" (bi,j) activity
durations using the formulas:

386
(11.1)

and

(10.2)

where and are the mean duration and its variance, respectively, of
an activity (i,j). Three activity durations estimates (i.e., optimistic, most likely, and
pessimistic durations) are required in the calculation. The use of these optimistic,
most likely, and pessimistic estimates stems from the fact that these are thought to
be easier for managers to estimate subjectively. The formulas for calculating the
mean and variance are derived by assuming that the activity durations follow a
probabilistic beta distribution under a restrictive condition. [2] The probability
density function of a beta distributions for a random varable x is given by:

(11.3)

where k is a constant which can be expressed in terms of and . Several beta

distributions for different sets of values of and are shown in Figure 11-1. For

a beta distribution in the interval having a modal value m, the mean

is given by:

(11.4)

If + = 4, then Eq. (11.4) will result in Eq. (11.1). Thus, the use of Eqs. (11.1)
and (11.2) impose an additional condition on the beta distribution. In particular, the
restriction that = (b - a)/6 is imposed.

387
Figure 11-1 Illustration of Several Beta Distributions

Since absolute limits on the optimistic and pessimistic activity durations are
extremely difficult to estimate from historical data, a common practice is to use the
ninety-fifth percentile of activity durations for these points. Thus, the optimistic
time would be such that there is only a one in twenty (five percent) chance that the
actual duration would be less than the estimated optimistic time. Similarly, the
pessimistic time is chosen so that there is only a five percent chance of exceeding
this duration. Thus, there is a ninety percent chance of having the actual duration of
an activity fall between the optimistic and pessimistic duration time estimates. With
the use of ninety-fifth percentile values for the optimistic and pessimistic activity
duration, the calculation of the expected duration according to Eq. (11.1) is
unchanged but the formula for calculating the activity variance becomes:

(11.5)

388
The difference between Eqs. (11.2) and (11.5) comes only in the value of the
divisor, with 36 used for absolute limits and 10 used for ninety-five percentile
limits. This difference might be expected since the difference between bi,j and
ai,j would be larger for absolute limits than for the ninety-fifth percentile limits.

While the PERT method has been made widely available, it suffers from three
major problems. First, the procedure focuses upon a single critical path, when many
paths might become critical due to random fluctuations. For example, suppose that
the critical path with longest expected time happened to be completed early.
Unfortunately, this does not necessarily mean that the project is completed early
since another path or sequence of activities might take longer. Similarly, a longer
than expected duration for an activity not on the critical path might result in that
activity suddenly becoming critical. As a result of the focus on only a single path,
the PERT method typically underestimates the actual project duration.

As a second problem with the PERT procedure, it is incorrect to assume that most
construction activity durations are independent random variables. In practice,
durations are correlated with one another. For example, if problems are
encountered in the delivery of concrete for a project, this problem is likely to
influence the expected duration of numerous activities involving concrete pours on
a project. Positive correlations of this type between activity durations imply that the
PERT method underestimates the variance of the critical path and thereby produces
over-optimistic expectations of the probability of meeting a particular project
completion deadline.

Finally, the PERT method requires three duration estimates for each activity rather
than the single estimate developed for critical path scheduling. Thus, the difficulty
and labor of estimating activity characteristics is multiplied threefold.

As an alternative to the PERT procedure, a straightforward method of obtaining

information about the distribution of project completion times (as well as other
schedule information) is through the use of Monte Carlo simulation. This technique
calculates sets of artificial (but realistic) activity duration times and then applies a
deterministic scheduling procedure to each set of durations. Numerous calculations
are required in this process since simulated activity durations must be calculated
and the scheduling procedure applied many times. For realistic project networks, 40
to 1,000 separate sets of activity durations might be used in a single scheduling
simulation. The calculations associated with Monte Carlo simulation are described
in the following section.

A number of different indicators of the project schedule can be estimated from the
results of a Monte Carlo simulation:

• Estimates of the expected time and variance of the project completion.

389
 • An estimate of the distribution of completion times, so that the probability of
meeting a particular completion date can be estimated.
• The probability that a particular activity will lie on the critical path. This is
of interest since the longest or critical path through the network may change
as activity durations change.

The disadvantage of Monte Carlo simulation results from the additional

information about activity durations that is required and the computational effort
involved in numerous scheduling applications for each set of simulated durations.
For each activity, the distribution of possible durations as well as the parameters of
this distribution must be specified. For example, durations might be assumed or
estimated to be uniformly distributed between a lower and upper value. In
addition, correlations between activity durations should be specified. For example,
if two activities involve assembling forms in different locations and at different
times for a project, then the time required for each activity is likely to be closely
related. If the forms pose some problems, then assembling them on both occasions
might take longer than expected. This is an example of a positive correlation in
activity times. In application, such correlations are commonly ignored, leading to
errors in results. As a final problem and discouragement, easy to use software
systems for Monte Carlo simulation of project schedules are not generally
available. This is particularly the case when correlations between activity durations
are desired.

Another approach to the simulation of different activity durations is to develop

specific scenarios of events and determine the effect on the overall project
schedule. This is a type of "what-if" problem solving in which a manager simulates
events that might occur and sees the result. For example, the effects of different
weather patterns on activity durations could be estimated and the resulting
schedules for the different weather patterns compared. One method of obtaining
information about the range of possible schedules is to apply the scheduling
procedure using all optimistic, all most likely, and then all pessimistic activity
durations. The result is three project schedules representing a range of possible
outcomes. This process of "what-if" analysis is similar to that undertaken during
the process of construction planning or during analysis of project crashing.

Example 11-1: Scheduling activities with uncertain time durations.

Suppose that the nine activity example project shown in Table 10-2 and Figure 10-
4 of Chapter 10 was thought to have very uncertain activity time durations. As a
result, project scheduling considering this uncertainty is desired. All three methods
(PERT, Monte Carlo simulation, and "What-if" simulation) will be applied.

Table 11-1 shows the estimated optimistic, most likely and pessimistic durations
for the nine activities. From these estimates, the mean, variance and standard
deviation are calculated. In this calculation, ninety-fifth percentile estimates of

390
optimistic and pessimistic duration times are assumed, so that Equation (11.5) is
applied. The critical path for this project ignoring uncertainty in activity durations
consists of activities A, C, F and I as found in Table 10-3 (Section 10.3). Applying
the PERT analysis procedure suggests that the duration of the project would be
approximately normally distributed. The sum of the means for the critical activities
is 4.0 + 8.0 + 12.0 + 6.0 = 30.0 days, and the sum of the variances is 0.4 + 1.6 + 1.6
+ 1.6 = 5.2 leading to a standard deviation of 2.3 days.

With a normally distributed project duration, the probability of meeting a project

deadline is equal to the probability that the standard normal distribution is less than
or equal to (PD - D)| D where PD is the project deadline, D is the expected
duration and D is the standard deviation of project duration. For example, the
probability of project completion within 35 days is:

where z is the standard normal distribution tabulated value of the cumulative

standard distribution appears in Table B.1 of Appendix B.

Monte Carlo simulation results provide slightly different estimates of the project
duration characteristics. Assuming that activity durations are independent and
approximately normally distributed random variables with the mean and variances
shown in Table 11-1, a simulation can be performed by obtaining simulated
duration realization for each of the nine activities and applying critical path
scheduling to the resulting network. Applying this procedure 500 times, the average
project duration is found to be 30.9 days with a standard deviation of 2.5 days. The
PERT result is less than this estimate by 0.9 days or three percent. Also, the critical
path considered in the PERT procedure (consisting of activities A, C, F and I) is
found to be the critical path in the simulated networks less than half the time.

TABLE 11-1 Activity Duration Estimates for a Nine Activity Project

Activity Optimistic Duration Most Likely Duration Pessimistic Duration Mean Variance
A 3 4 5 4.0 0.4
B 2 3 5 3.2 0.9
C 6 8 10 8.0 1.6
D 5 7 8 6.8 0.9
E 6 9 14 9.3 6.4
F 10 12 14 12.0 1.6
G 2 2 4 2.3 0.4
H 4 5 8 5.3 1.6

391
 I 4 6 8 6.0 1.6

If there are correlations among the activity durations, then significantly different
results can be obtained. For example, suppose that activities C, E, G and H are all
positively correlated random variables with a correlation of 0.5 for each pair of
variables. Applying Monte Carlo simulation using 500 activity network simulations
results in an average project duration of 36.5 days and a standard deviation of 4.9
days. This estimated average duration is 6.5 days or 20 percent longer than the
PERT estimate or the estimate obtained ignoring uncertainty in durations. If
correlations like this exist, these methods can seriously underestimate the actual
project duration.

Finally, the project durations obtained by assuming all optimistic and all
pessimistic activity durations are 23 and 41 days respectively. Other "what-if"
simulations might be conducted for cases in which peculiar soil characteristics
might make excavation difficult; these soil peculiarities might be responsible for
the correlations of excavation activity durations described above.

Results from the different methods are summarized in Table 11-2. Note that
positive correlations among some activity durations results in relatively large
increases in the expected project duration and variability.

TABLE 11-2 Project Duration Results from Various Techniques and Assumptions for an
Example
Standard Deviation
Procedure and Assumptions Project Duration (days) of Project Duration (days)
Critical Path Method 30.0 NA
PERT Method 30.0 2.3
Monte Carlo Simulation
No Duration Correlations 30.9 2.5
Positive Duration Correlations 36.5 4.9
"What-if" Simulations
Optimistic 23.0 NA
Most Likely 30.0 NA
Pessimistic 41.0 NA

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11.3 Calculations for Monte Carlo Schedule Simulation

In this section, we outline the procedures required to perform Monte Carlo
simulation for the purpose of schedule analysis. These procedures presume that the
various steps involved in forming a network plan and estimating the characteristics

392
of the probability distributions for the various activities have been completed.
Given a plan and the activity duration distributions, the heart of the Monte Carlo
simulation procedure is the derivation of arealization or synthetic outcome of the
relevant activity durations. Once these realizations are generated, standard
scheduling techniques can be applied. We shall present the formulas associated
with the generation of normally distributed activity durations, and then comment on
the requirements for other distributions in an example.

To generate normally distributed realizations of activity durations, we can use a

two step procedure. First, we generate uniformly distributed random variables, ui in
the interval from zero to one. Numerous techniques can be used for this purpose.
For example, a general formula for random number generation can be of the form:

(11.6)

where = 3.14159265 and ui-1 was the previously generated random number or a
pre-selected beginning or seed number. For example, a seed of u 0 = 0.215 in Eq.
(11.6) results in u1 = 0.0820, and by applying this value of u1, the result is u2 =
0.1029. This formula is a special case of the mixed congruential method of random
number generation. While Equation (11.6) will result in a series of numbers that
have the appearance and the necessary statistical properties of true random
numbers, we should note that these are actually "pseudo" random numbers since
the sequence of numbers will repeat given a long enough time.

With a method of generating uniformly distributed random numbers, we can

generate normally distributed random numbers using two uniformly distributed
realizations with the equations: [3]

(11.7)

with

where xk is the normal realization, x is the mean of x, x is the standard

deviation of x, and u1 and u2 are the two uniformly distributed random variable
realizations. For the case in which the mean of an activity is 2.5 days and the
standard deviation of the duration is 1.5 days, a corresponding realization of the
duration is s = 2.2365, t = 0.6465 and xk = 2.525 days, using the two uniform
random numbers generated from a seed of 0.215 above.

393
Correlated random number realizations may be generated making use of
conditional distributions. For example, suppose that the duration of an activity d is
normally distributed and correlated with a second normally distributed random
variable x which may be another activity duration or a separate factor such as a
weather effect. Given a realization xk of x, the conditional distribution of d is still
normal, but it is a function of the value xk. In particular, the conditional mean ( 'd|
x = xk) and standard deviation ( 'd|x = xk) of a normally distributed variable given
a realization of the second variable is:

(11.8)

where dx is the correlation coefficient between d and x. Once xk is known, the

conditional mean and standard deviation can be calculated from Eq. (11.8) and then
a realization of d obtained by applying Equation (11.7).

Correlation coefficients indicate the extent to which two random variables will tend
to vary together. Positive correlation coefficients indicate one random variable will
tend to exceed its mean when the other random variable does the same. From a set
of n historical observations of two random variables, x and y, the correlation
coefficient can be estimated as:

(11.9)

The value of xy can range from one to minus one, with values near one indicating
a positive, near linear relationship between the two random variables.

It is also possible to develop formulas for the conditional distribution of a random

variable correlated with numerous other variables; this is termed a multi-variate
distribution. [4] Random number generations from other types of distributions are
also possible. [5] Once a set of random variable distributions is obtained, then the
process of applying a scheduling algorithm is required as described in previous
sections.

Example 11-2: A Three-Activity Project Example

394
Suppose that we wish to apply a Monte Carlo simulation procedure to a simple
project involving three activities in series. As a result, the critical path for the
project includes all three activities. We assume that the durations of the activities
are normally distributed with the following parameters:
Activity Mean (Days) Standard Deviation (Days)
A 2.5 1.5
B 5.6 2.4
C 2.4 2.0

To simulate the schedule effects, we generate the duration realizations shown in

Table 11-3 and calculate the project duration for each set of three activity duration
realizations.

For the twelve sets of realizations shown in the table, the mean and standard
deviation of the project duration can be estimated to be 10.49 days and 4.06 days
respectively. In this simple case, we can also obtain an analytic solution for this
duration, since it is only the sum of three independent normally distributed
variables. The actual project duration has a mean of 10.5 days, and a standard

deviation of days. With only a limited number

of simulations, the mean obtained from simulations is close to the actual mean,
while the estimated standard deviation from the simulation differs significantly
from the actual value. This latter difference can be attributed to the nature of the set
of realizations used in the simulations; using a larger number of simulated
durations would result in a more accurate estimate of the standard deviation.

TABLE 11-3 Duration Realizations for a Monte Carlo Schedule Simulation

Simulation Number Activity A Activity B Activity C Project Duration
1 1.53 6.94 1.04 9.51
2 2.67 4.83 2.17 9.66
3 3.36 6.86 5.56 15.78
4 0.39 7.65 2.17 10.22
5 2.50 5.82 1.74 10.06
6 2.77 8.71 4.03 15.51
7 3.83 2.05 1.10 6.96
8 3.73 10.57 3.24 17.53
9 1.06 3.68 2.47 7.22
10 1.17 0.86 1.37 3.40
11 1.68 9.47 0.13 11.27
12 0.37 6.66 1.70 8.72
Estimated Mean Project Duration = 10.49
Estimated Standard Deviation of Project Duration = 4.06
Note: All durations in days.

Example 11-3: Generation of Realizations from Triangular Distributions

395
To simplify calculations for Monte Carlo simulation of schedules, the use of a
triangular distribution is advantageous compared to the normal or the beta
distributions. Triangular distributions also have the advantage relative to the normal
distribution that negative durations cannot be estimated. As illustrated in Figure 11-
2, the triangular distribution can be skewed to the right or left and has finite limits
like the beta distribution. If a is the lower limit, b the upper limit and m the most
likely value, then the mean and standard deviation of a triangular distribution are:

(11.10)

(11.11)

The cumulative probability function for the triangular distribution is:

(11.12)

where F(x) is the probability that the random variable is less than or equal to the
value of x.

396
Figure 11-2 Illustration of Two Triangular Activity Duration Distributions

Generating a random variable from this distribution can be accomplished with a

single uniform random variable realization using the inversion method. In this
method, a realization of the cumulative probability function, F(x) is generated and
the corresponding value of x is calculated. Since the cumulative probability
function varies from zero to one, the density function realization can be obtained
from the uniform value random number generator, Equation (11.6). The calculation
of the corresponding value of x is obtained from inverting Equation (11.12):

(11.13)

For example, if a = 3.2, m = 4.5 and b = 6.0, then x = 4.8 and x = 2.7. With a
uniform realization of u = 0.215, then for (m-a)/(b-a) 0.215, x will lie between a
and m and is found to have a value of 4.1 from Equation (11.13).

397
Back to top

11.4 Crashing and Time/Cost Tradeoffs

The previous sections discussed the duration of activities as either fixed or random
numbers with known characteristics. However, activity durations can often vary
depending upon the type and amount of resources that are applied. Assigning more
workers to a particular activity will normally result in a shorter
duration. [6] Greater speed may result in higher costs and lower quality, however.
In this section, we shall consider the impacts of time, cost and quality tradeoffs in
activity durations. In this process, we shall discuss the procedure of project
crashing as described below.

A simple representation of the possible relationship between the duration of an

activity and its direct costs appears in Figure 11-3. Considering only this activity in
isolation and without reference to the project completion deadline, a manager
would undoubtedly choose a duration which implies minimum direct cost,
represented by Dij and Cij in the figure. Unfortunately, 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 start-up might be incurred. This is a small example
of sub-optimization, in which a small component of a project is optimized or
improved to the detriment of the entire project performance. Avoiding this problem
of sub-optimization is a fundamental concern of project managers.

398
Figure 11-3 Illustration of a Linear Time/Cost Tradeoff for an Activity

At the other extreme, a manager might choose to complete the activity in the
minimum possible time, Dcij, but at a higher cost Ccij. This minimum completion
time is commonly called the activity crash time. The linear relationship shown in
the figure between these two points implies that any intermediate duration could
also be chosen. It is possible that some intermediate point may represent the ideal
or optimal trade-off between time and cost for this activity.

What is the reason for an increase in direct cost as the activity duration is reduced?
A simple case arises in the use of overtime work. By scheduling weekend or
evening work, the completion time for an activity as measured in calendar days will
be reduced. However, premium wages must be paid for such overtime work, so the
cost will increase. Also, overtime work is more prone to accidents and quality
problems that must be corrected, so indirect costs may also increase. More
generally, we might not expect a linear relationship between duration and direct
cost, but some convex function such as the nonlinear curve or the step function
shown in Figure 11-4. A linear function may be a good approximation to the actual
curve, however, and results in considerable analytical simplicity. [7]

Figure 11-4 Illustration of Non-linear Time/Cost Tradeoffs for an Activity

399
With a linear relationship between cost and duration, the critical path time/cost
tradeoff problem can be defined as a linear programming optimization problem. In
particular, let Rij represent the rate of change of cost as duration is decreased,
illustrated by the absolute value of the slope of the line in Figure 11-3. Then, the
direct cost of completing an activity is:

(11.14)

where the lower case cij and dij represent the scheduled duration and resulting cost
of the activity ij. The actual duration of an activity must fall between the minimum
cost time (Dij) and the crash time (Dcij). Also, precedence constraints must be
imposed as described earlier for each activity. Finally, the required completion time
for the project or, alternatively, the costs associated with different completion times
must be defined. Thus, the entire scheduling problem is to minimize total cost
(equal to the sum of the cij values for all activities) subject to constraints arising
from (1) the desired project duration, PD, (2) the minimum and maximum activity
duration possibilities, and (3) constraints associated with the precedence or
completion times of activities. Algebraically, this is:

(11.15)

subject to the constraints:

where the notation is defined above and the decision variables are the activity
durations dij and event times x(k). The appropriate schedules for different project
durations can be found by repeatedly solving this problem for different project
durations PD. The entire problem can be solved by linear programming or more
efficient algorithms which take advantage of the special network form of the
problem constraints.

One solution to the time-cost tradeoff problem is of particular interest and deserves
mention here. The minimum time to complete a project is called the project-crash
time. This minimum completion time can be found by applying critical path

400
scheduling with all activity durations set to their minimum values (Dcij). This
minimum completion time for the project can then be used in the time-cost
scheduling problem described above to determine the minimum project-crash cost.
Note that the project crash cost is not found by setting each activity to its crash
duration and summing up the resulting costs; this solution is called the all-crash
cost. Since there are some activities not on the critical path that can be assigned
longer duration without delaying the project, it is advantageous to change the all-
crash schedule and thereby reduce costs.

Heuristic approaches are also possible to the time/cost tradeoff problem. In

particular, a simple approach is to first apply critical path scheduling with all
activity durations assumed to be at minimum cost (Dij). Next, the planner can
examine activities on the critical path and reduce the scheduled duration of
activities which have the lowest resulting increase in costs. In essence, the planner
develops a list of activities on the critical path ranked in accordance with the unit
change in cost for a reduction in the activity duration. The heuristic solution
proceeds by shortening activities in the order of their lowest impact on costs. As the
duration of activities on the shortest path are shortened, the project duration is also
reduced. Eventually, another path becomes critical, and a new list of activities on
the critical path must be prepared. By manual or automatic adjustments of this kind,
good but not necessarily optimal schedules can be identified. Optimal or best
schedules can only be assured by examining changes in combinations of activities
as well as changes to single activities. However, by alternating between
adjustments in particular activity durations (and their costs) and a critical path
scheduling procedure, a planner can fairly rapidly devise a shorter schedule to meet
a particular project deadline or, in the worst case, find that the deadline is
impossible of accomplishment.

This type of heuristic approach to time-cost tradeoffs is essential when the time-
cost tradeoffs for each activity are not known in advance or in the case of resource
constraints on the project. In these cases, heuristic explorations may be useful to
determine if greater effort should be spent on estimating time-cost tradeoffs or if
additional resources should be retained for the project. In many cases, the basic
time/cost tradeoff might not be a smooth curve as shown in Figure 11-4, but only a
series of particular resource and schedule combinations which produce particular
durations. For example, a planner might have the option of assigning either one or
two crews to a particular activity; in this case, there are only two possible durations
of interest.

Example 11-4: Time/Cost Trade-offs

The construction of a permanent transitway on an expressway median illustrates the

possibilities for time/cost trade-offs in construction work. [8] One section of 10
miles of transitway was built in 1985 and 1986 to replace an existing contra-flow
lane system (in which one lane in the expressway was reversed each day to provide

401
additional capacity in the peak flow direction). Three engineers' estimates for work
time were prepared:

• 975 calendar day, based on 750 working days at 5 days/week and 8

hours/day of work plus 30 days for bad weather, weekends and holidays.
• 702 calendar days, based on 540 working days at 6 days/week and 10
hours/day of work.
• 360 calendar days, based on 7 days/week and 24 hours/day of work.

The savings from early completion due to operating savings in the contra-flow lane
and contract administration costs were estimated to be $5,000 per day.

In accepting bids for this construction work, the owner required both a dollar
amount and a completion date. The bidder's completion date was required to fall
between 360 and 540 days. In evaluating contract bids, a $5,000 credit was allowed
for each day less than 540 days that a bidder specified for completion. In the end,
the successful bidder completed the project in 270 days, receiving a bonus of
5,000*(540-270) = $450,000 in the $8,200,000 contract. However, the contractor
experienced fifteen to thirty percent higher costs to maintain the continuous work
schedule.

Example 11-5: Time cost trade-offs and project crashing

As an example of time/cost trade-offs and project crashing, suppose that we needed

to reduce the project completion time for a seven activity product delivery project
first analyzed in Section 10.3 as shown in Table 10-4 and Figure 10-7. Table 11-4
gives information pertaining to possible reductions in time which might be
accomplished for the various activities. Using the minimum cost durations (as
shown in column 2 of Table 11-4), the critical path includes activities C,E,F,G plus
a dummy activity X. The project duration is 32 days in this case, and the project
cost is $70,000.
TABLE 11-4 Activity Durations and Costs for a Seven Activity Project
Change in
Activity Minimum Cost Normal Duration Crash Cost Crash Duration Cost per Day
A 8 6 14 4 3
B 4 1 4 1 ---
C 8 8 24 4 4
D 10 5 24 3 7
E 10 9 18 5 2
F 20 12 36 6 2.7
G 10 3 18 2 8

Examining the unit change in cost, Rij shown in column 6 of Table 11-4, the lowest
rate of change occurs for activity E. Accordingly, a good heuristic strategy might

402
be to begin by crashing this activity. The result is that the duration of activity E
goes from 9 days to 5 days and the total project cost increases by $8,000. After
making this change, the project duration drops to 28 days and two critical paths
exist: (1) activities C,X,E,F and G, and (2) activities C, D, F, and G.

Examining the unit changes in cost again, activity F has the lowest value of Rijj.
Crashing this activity results in an additional time savings of 6 days in the project
duration, an increase in project cost of $16,000, but no change in the critical paths.
The activity on the critical path with the next lowest unit change in cost is activity
C. Crashing this activity to its minimum completion time would reduce its duration
by 4 days at a cost increase of $16,000. However, this reduction does not result in a
reduction in the duration of the project by 4 days. After activity C is reduced to 7
days, then the alternate sequence of activities A and B lie on the critical path and
further reductions in the duration of activity C alone do not result in project time
savings. Accordingly, our heuristic corrections might be limited to reducing
activity C by only 1 day, thereby increasing costs by $4,000 and reducing the
project duration by 1 day.

At this point, our choices for reducing the project duration are fairly limited. We
can either reduce the duration of activity G or, alternatively, reduce activity C and
either activity A or activity B by an identical amount. Inspection of Table 11-4 and
Figure 10-4 suggest that reducing activity A and activity C is the best alternative.
Accordingly, we can shorten activity A to its crash duration (from 6 days to 4 days)
and shorten the duration of activity C (from 7 days to 5 days) at an additional cost
of $6,000 + $8,000 = $14,000. The result is a reduction in the project duration of 2
days.

Our last option for reducing the project duration is to crash activity G from 3 days
to 2 days at an increase in cost of $8,000. No further reductions are possible in this
time since each activity along a critical path (comprised of activities A, B, E, F and
G) are at minimum durations. At this point, the project duration is 18 days and the
project cost is $120,000., representing a fifty percent reduction in project duration
and a seventy percent increase in cost. Note that not all the activities have been
crashed. Activity C has been reduced in duration to 5 days (rather than its 4 day
crash duration), while activity D has not been changed at all. If all activities had
been crashed, the total project cost would have been $138,000, representing a
useless expenditure of $18,000. The change in project cost with different project
durations is shown graphically in Figure 11-5.

403
Figure 11-5 Project Cost Versus Time for a Seven Activity Project

Example 11-8: Mathematical Formulation of Time-Cost Trade-offs

The same results obtained in the previous example could be obtained using a
formal optimization program and the data appearing in Tables 10-4 and 11-4. In
this case, the heuristic approach used above has obtained the optimal solution at
each stage. Using Eq. (11.15), the linear programming problem formulation would
be:

Minimize z

= [8+3(6-dA)] + [4] + [8+4(8-dC)] + [10+7(5-dD)]

+ [10+2(9-dE)] + [20+2.7(9-dF)] + [10+2(3-dG)]
subject to the constraints
x(6) = PD x(0) + dA x(2)
x(0) + dC x(1)
x(1) x(3)
x(2) + dB x(4)
x(1) + dD x(4)
x(2) + dE x(4)
x(4) + dF x(5)
x(5) + dG x(6)

404
x(0) = 0
4 dA 6
1 dB 1
4 dC 8
3 dD 5
5 dE 9
6 dF 12
2 dG 3

which can be solved for different values of project duration PD using a linear
programming algorithm or a network flow algorithm. Note that even with only
seven activities, the resulting linear programming problem is fairly large.

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11.5 Scheduling in Poorly Structured Problems

The previous discussion of activity scheduling suggested that the general structure
of the construction plan was known in advance. With previously defined activities,
relationships among activities, and required resources, the scheduling problem
could be represented as a mathematical optimization problem. Even in the case in
which durations are uncertain, we assumed that the underlying probability
distribution of durations is known and applied analytical techniques to investigate
schedules.

While these various scheduling techniques have been exceedingly useful, they do
not cover the range of scheduling problems encountered in practice. In particular,
there are many cases in which costs and durations depend upon other activities due
to congestion on the site. In contrast, the scheduling techniques discussed
previously assume that durations of activities are generally independent of each
other. A second problem stems from the complexity of construction technologies.
In the course of resource allocations, numerous additional constraints or objectives
may exist that are difficult to represent analytically. For example, different workers
may have specialized in one type of activity or another. With greater experience,
the work efficiency for particular crews may substantially increase. Unfortunately,
representing such effects in the scheduling process can be very difficult. Another
case of complexity occurs when activity durations and schedules are negotiated
among the different parties in a project so there is no single overall planner.

A practical approach to these types of concerns is to insure that all schedules are
reviewed and modified by experienced project managers before implementation.
This manual review permits the incorporation of global constraints or consideration
of peculiarities of workers and equipment. Indeed, interactive schedule revision to
accomadate resource constraints is often superior to any computer based heuristic.

405
With improved graphic representations and information availability, man-machine
interaction is likely to improve as a scheduling procedure.

More generally, the solution procedures for scheduling in these more complicated
situations cannot be reduced to mathematical algorithms. The best solution
approach is likely to be a "generate-and-test" cycle for alternative plans and
schedules. In this process, a possible schedule is hypothesized or generated. This
schedule is tested for feasibility with respect to relevant constraints (such as
available resources or time horizons) and desireability with respect to different
objectives. Ideally, the process of evaluating an alternative will suggest directions
for improvements or identify particular trouble spots. These results are then used in
the generation of a new test alternative. This process continues until a satisfactory
plan is obtained.

Two important problems must be borne in mind in applying a "generate-and-test"

strategy. First, the number of possible plans and schedules is enormous, so
considerable insight to the problem must be used in generating reasonable
alternatives. Secondly, evaluating alternatives also may involve considerable effort
and judgment. As a result, the number of actual cycles of alternative testing that can
be accomadated is limited. One hope for computer technology in this regard is that
the burdensome calculations associated with this type of planning may be assumed
by the computer, thereby reducing the cost and required time for the planning
effort. Some mechanisms along these lines are described in Chapter 15.

Example 11-9: Man-machine Interactive Scheduling

An interactive system for scheduling with resource constraints might have the
following characteristics: [9]

• graphic displays of bar charts, resource use over time, activity networks and
other graphic images available in different windows of a screen
simultaneously,
• descriptions of particular activities including allocated resources and chosen
technologies available in windows as desired by a user,
• a three dimensional animation of the construction process that can be
stopped to show the progress of construction on the facility at any time,
• easy-to-use methods for changing start times and allocated resources, and
• utilities to run relevant scheduling algorithms such as the critical path
method at any time.

Figure 11-6 shows an example of a screen for this system. In Figure 11-6, a bar
chart appears in one window, a description of an activity in another window, and a
graph of the use of a particular resource over time appears in a third window. These
different "windows" appear as sections on a computer screen displaying different
types of information. With these capabilities, a project manager can call up

406
different pictures of the construction plan and make changes to accomadate
objectives or constraints that are not formally represented. With rapid response to
such changes, the effects can be immediately evaluated.

Figure 11-6 Example of a Bar Chart and Other Windows for Interactive
Scheduling

Back to top

11.6 Improving the Scheduling Process

Despite considerable attention by researchers and practitioners, the process of
construction planning and scheduling still presents problems and opportunities for
improvement. The importance of scheduling in insuring the effective coordination

407
of work and the attainment of project deadlines is indisputable. For large projects
with many parties involved, the use of formal schedules is indispensable.

The network model for representing project activities has been provided as an
important conceptual and computational framework for planning and scheduling.
Networks not only communicate the basic precedence relationships between
activities, they also form the basis for most scheduling computations.

As a practical matter, most project scheduling is performed with the critical path
scheduling method, supplemented by heuristic procedures used in project crash
analysis or resource constrained scheduling. Many commercial software programs
are available to perform these tasks. Probabilistic scheduling or the use of
optimization software to perform time/cost trade-offs is rather more infrequently
applied, but there are software programs available to perform these tasks if desired.

Rather than concentrating upon more elaborate solution algorithms, the most
important innovations in construction scheduling are likely to appear in the areas of
data storage, ease of use, data representation, communication and diagnostic or
interpretation aids. Integration of scheduling information with accounting and
design information through the means of database systems is one beneficial
innovation; many scheduling systems do not provide such integration of
information. The techniques discussed in Chapter 14 are particularly useful in this
regard.

With regard to ease of use, the introduction of interactive scheduling systems,

graphical output devices and automated data acquisition should produce a very
different environment than has existed. In the past, scheduling was performed as a
batch operation with output contained in lengthy tables of numbers. Updating of
work progress and revising activity duration was a time consuming manual task. It
is no surprise that managers viewed scheduling as extremely burdensome in this
environment. The lower costs associated with computer systems as well as
improved software make "user friendly" environments a real possibility for field
operations on large projects.

Finally, information representation is an area which can result in substantial

improvements. While the network model of project activities is an extremely useful
device to represent a project, many aspects of project plans and activity inter-
relationships cannot or have not been represented in network models. For example,
the similarity of processes among different activities is usually unrecorded in the
formal project representation. As a result, updating a project network in response to
new information about a process such as concrete pours can be tedious. What is
needed is a much more flexible and complete representation of project information.
Some avenues for change along these lines are discussed in Chapter 15.

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408
11.7 References
1. Bratley, Paul, Bennett L. Fox and Linus E. Schrage, A Guide to Simulation,
Springer-Verlag, 1973.
2. Elmaghraby, S.E., Activity Networks: Project Planning and Control by
Network Models, John Wiley, New York, 1977.
3. Jackson, M.J., Computers in Construction Planning and Control, Allen &
Unwin, London, 1986.
4. Moder, J., C. Phillips and E. Davis, Project Management with CPM, PERT
and Precedence Diagramming, Third Edition, Van Nostrand Reinhold
Company, 1983.

Back to top

11.8 Problems
1. For the project defined in Problem 1 from Chapter 10, suppose that the early,
most likely and late time schedules are desired. Assume that the activity
durations are approximately normally distributed with means as given in
Table 10-16 and the following standard deviations: A: 4; B: 10; C: 1; D: 15;
E: 6; F: 12; G: 9; H: 2; I: 4; J: 5; K: 1; L: 12; M: 2; N: 1; O: 5. (a) Find the
early, most likely and late time schedules, and (b) estimate the probability
that the project requires 25% more time than the expected duration.

2. For the project defined in Problem 2 from Chapter 10, suppose that the early,
most likely and late time schedules are desired. Assume that the activity
durations are approximately normally distributed with means as given in
Table 10-17 and the following standard deviations: A: 2, B: 2, C: 1, D: 0, E:
0, F: 2; G: 0, H: 0, I: 0, J: 3; K: 0, L: 3; M: 2; N: 1. (a) Find the early, most
likely and late time schedules, and (b) estimate the probability that the
project requires 25% more time than the expected duration.

3 to 6
The time-cost tradeoff data corresponding to each of the Problems 1 to 4 (in
Chapter 10), respectively are given in the table for the problem (Tables 11-5
to 11-8). Determine the all-crash and the project crash durations and cost
based on the early time schedule for the project. Also, suggest a combination
of activity durations which will lead to a project completion time equal to
three days longer than the project crash time but would result in the
(approximately) maximum savings.
TABLE 11-5
Activity A B C D E F G H I J K L M N O

409
Shortest
Possible
Completion
Time 3 5 1 10 4 6 6 2 4 3 3 3 2 2 5
Normal
Completion
Time Cost 150 250 80 400 220 300 260 120 200 180 220 500 100 120 500
Change in
Cost Per
Day
Earlier
Completion 20 30 Infinity 15 20 25 10 35 20 Infinity 25 15 30 Infinity 10
TABLE 11-6
Activity A B C D E F G H I J K L M N
Shortest Possible
Completion Time 2 4 1 3 3 5 2 1 2 6 1 4 3 2
Normal
Completion
Time Cost 400 450 200 300 350 550 250 180 150 480 120 500 280 220
Crash Completion
Time Cost 460 510 250 350 430 640 300 250 150 520 150 560 320 260
TABLE 11-7
Activity A B C D E F G H I J K L
Shortest
Possible
Completion
Time 4 8 11 4 1 9 6 2 3 2 7 3
Normal
Completion
Time Cost 70 150 200 60 40 120 100 50 70 60 120 70
Crash
Completion
Time Cost 90 210 250 80 60 140 130 70 90 80 150 100
TABLE 11-8
Activity A B C D E F G H I J K L M
Shortest Possible
Completion Time 3 5 2 2 5 3 5 6 6 4 5 2 2
Normal Completion
Time Cost 50 150 90 125 300 240 80 270 120 600 300 80 140
Change in Cost Per
Day
Earlier Completion Infinity 50 Infinity 40 30 20 15 30 Infinity 40 50 40 40
7 to 10

410
 Develop a project completion time versus cost tradeoff curve for the projects
in Problems 3 to 6. (Note: a linear programming computer program or more
specialized programs can reduce the calculating work involved in these
problems!)

11.Suppose that the project described in Problem 5 from Chapter 10 proceeds

normally on an earliest time schedule with all activities scheduled for their
normal completion time. However, suppose that activity G requires 20 days
rather than the expected 5. What might a project manager do to insure
completion of the project by the originally planned completion time?

12. For the project defined in Problem 1 from Chapter 10, suppose that a Monte
Carlo simulation with ten repetitions is desired. Suppose further that the
activity durations have a triangular distribution with the following lower and
upper bounds: A:4,8; B:4,9, C: 0.5,2; D: 10,20; E: 4,7; F: 7,10; G: 8, 12; H:
2,4; I: 4,7; J: 2,4; K: 2,6; L: 10, 15; M: 2,9; N: 1,4; O: 4,11.
(a) Calculate the value of m for each activity given the upper and lower
bounds and the expected duration shown in Table 10-16.
(b) Generate a set of realizations for each activity and calculate the resulting
project duration.
(c) Repeat part (b) five times and estimate the mean and standard deviation
of the project duration.

13.Suppose that two variables both have triangular distributions and are
correlated. The resulting multi-variable probability density function has a
triangular shape. Develop the formula for the conditional distribution of one
variable given the corresponding realization of the other variable.

Back to top

11.9 Footnotes
1. See D. G. Malcolm, J.H. Rosenbloom, C.E. Clark, and W. Fazar, "Applications
of a Technique for R and D Program Evaluation," Operations Research, Vol. 7,
No. 5, 1959, pp. 646-669. Back

2. See M.W. Sasieni, "A Note on PERT Times," Management Science, Vol. 32, No.
12, p 1986, p. 1652-1653, and T.K. Littlefield and P.H. Randolph, "An Answer to
Sasieni's Question on Pert Times," Management Science, Vol. 33, No. 10, 1987, pp.
1357-1359. For a general discussion of the Beta distribution, see N.L. Johnson and

411
S. Kotz, Continuous Univariate Distributions-2, John Wiley & Sons, 1970, Chapter
24. Back

3. See T. Au, R.M. Shane, and L.A. Hoel, Fundamentals of Systems Engineering -
Probabilistic Models, Addison-Wesley Publishing Company, 1972. Back

4. See N.L. Johnson and S. Kotz, Distributions in Statistics: Continuous

Multivariate Distributions, John Wiley & Sons, New York, 1973. Back

5. See, for example, P. Bratley, B. L. Fox and L.E. Schrage, A Guide to Simulation,
Springer-Verlag, New York, 1983. Back

6. There are exceptions to this rule, though. More workers may also mean
additional training burdens and more problems of communication and
management. Some activities cannot be easily broken into tasks for numerous
individuals; some aspects of computer programming provide notable examples.
Indeed, software programming can be so perverse that examples exist of additional
workers resulting in slower project completion. See F.P. Brooks, jr. , The Mythical
Man-Month, Addison Wesley, Reading, MA 1975. Back

7. For a discussion of solution procedures and analogies of the general function

time/cost tradeoff problem, see C. Hendrickson and B.N. Janson, "A Common
Network Flow Formulation for Several Civil Engineering Problems," Civil
Engineering Systems, Vol. 1, No. 4, 1984, pp. 195-203. Back

8. This example was abstracted from work performed in Houston and reported in
U. Officer, "Using Accelerated Contracts with Incentive Provisions for Transitway
Construction in Houston," Paper Presented at the January 1986 Transportation
Research Board Annual Conference, Washington, D.C. Back

9. This description is based on an interactive scheduling system developed at

Carnegie Mellon University and described in C. Hendrickson, C. Zozaya-
Gorostiza, D. Rehak, E. Baracco-Miller and P. Lim, "An Expert System for
Construction Planning," ASCE Journal of Computing, Vol. 1, No. 4, 1987, pp. 253-
269. Back

412
12. Cost Control, Monitoring and
Accounting
12.1 The Cost Control Problem
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. These tools serve the dual purpose of recording the financial transactions
that occur as well as giving managers an indication of the progress and problems
associated with a project. The problems of project control are aptly summed up in
an old definition of a project as "any collection of vaguely related activities that are
ninety percent complete, over budget and late." [1] The task of project control
systems is to give a fair indication of the existence and the extent of such problems.

In this chapter, we consider the problems associated with resource utilization,

accounting, monitoring and control during a project. In this discussion, we
emphasize the project management uses of accounting information. Interpretation
of project accounts is generally not straightforward until a project is completed, and
then it is too late to influence project management. Even after completion of a
project, the accounting results may be confusing. Hence, managers need to know
how to interpret accounting information for the purpose of project management. In
the process of considering management problems, however, we shall discuss some
of the common accounting systems and conventions, although our purpose is not to
provide a comprehensive survey of accounting procedures.

The limited objective of project control deserves emphasis. Project control

procedures are primarily intended to identify deviations from the project plan rather
than to suggest possible areas for cost savings. This characteristic reflects the
advanced stage at which project control becomes important. The time at which
major cost savings can be achieved is during planning and design for the project.
During the actual construction, changes are likely to delay the project and lead to
inordinate cost increases. As a result, the focus of project control is on fulfilling the
original design plans or indicating deviations from these plans, rather than on
searching for significant improvements and cost savings. It is only when a rescue
operation is required that major changes will normally occur in the construction
plan.

Finally, the issues associated with integration of information will require some
discussion. Project management activities and functional concerns are intimately
linked, yet the techniques used in many instances do not facilitate comprehensive
or integrated consideration of project activities. For example, schedule information
and cost accounts are usually kept separately. As a result, project managers

413
themselves must synthesize a comprehensive view from the different reports on the
project plus their own field observations. In particular, managers are often forced to
infer the cost impacts of schedule changes, rather than being provided with aids for
this process. Communication or integration of various types of information can
serve a number of useful purposes, although it does require special attention in the
establishment of project control procedures.

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12.2 The Project Budget

For cost control on a project, the construction plan and the associated cash flow
estimates can provide the baseline reference for subsequent project monitoring and
control. For schedules, progress on individual activities and the achievement of
milestone completions can be compared with the project schedule to monitor the
progress of activities. Contract and job specifications provide the criteria by which
to assess and assure the required quality of construction. The final or detailed cost
estimate provides a baseline for the assessment of financial performance during the
project. To the extent that costs are within the detailed cost estimate, then the
project is thought to be under financial control. Overruns in particular cost
categories signal the possibility of problems and give an indication of exactly what
problems are being encountered. Expense oriented construction planning and
control focuses upon the categories included in the final cost estimation. This focus
is particular relevant for projects with few activities and considerable repetition
such as grading and paving roadways.

For control and monitoring purposes, the original detailed cost estimate is typically
converted to a project budget, and the project budget is used subsequently as a
guide for management. Specific items in the detailed cost estimate become job cost
elements. Expenses incurred during the course of a project are recorded in specific
job cost accounts to be compared with the original cost estimates in each category.
Thus, individual job cost accounts generally represent the basic unit for cost
control. Alternatively, job cost accounts may be disaggregated or divided into work
elements which are related both to particular scheduled activities and to particular
cost accounts. Work element divisions will be described in Section 12.8.

In addition to cost amounts, information on material quantities and labor inputs

within each job account is also typically retained in the project budget. With this
information, actual materials usage and labor employed can be compared to the
expected requirements. As a result, cost overruns or savings on particular items can
be identified as due to changes in unit prices, labor productivity or in the amount of
material consumed.

The number of cost accounts associated with a particular project can vary
considerably. For constructors, on the order of four hundred separate cost accounts

414
might be used on a small project. [2] These accounts record all the transactions
associated with a project. Thus, separate accounts might exist for different types of
materials, equipment use, payroll, project office, etc. Both physical and non-
physical resources are represented, including overhead items such as computer use
or interest charges. Table 12-1 summarizes a typical set of cost accounts that might
be used in building construction. [3] Note that this set of accounts is organized
hierarchically, with seven major divisions (accounts 201 to 207) and numerous sub-
divisions under each division. This hierarchical structure facilitates aggregation of
costs into pre-defined categories; for example, costs associated with the
superstructure (account 204) would be the sum of the underlying subdivisions (ie.
204.1, 204.2, etc.) or finer levels of detail (204.61, 204.62, etc.). The sub-division
accounts in Table 12-1 could be further divided into personnel, material and other
resource costs for the purpose of financial accounting, as described in Section 12.4.

TABLE 12-1 Illustrative Set of Project Cost Accounts

201 Clearing and Preparing Site
202 Substructure
202.1 Excavation and Shoring
202.2 Piling
202.3 Concrete Masonry
202.31 Mixing and Placing
202.32 Formwork
202.33 Reinforcing
203 Outside Utilities (water, gas, sewer, etc.)
204 Superstructure
204.1 Masonry Construction
204.2 Structural Steel
204.3 Wood Framing, Partitions, etc.
204.4 Exterior Finishes (brickwork, terra cotta, cut stone, etc.)
204.5 Roofing, Drains, Gutters, Flashing, etc.
204.6 Interior Finish and Trim
204.61 Finish Flooring, Stairs, Doors, Trim
204.62 Glass, Windows, Glazing
204.63 Marble, Tile, Terrazzo
204.64 Lathing and Plastering
204.65 Soundproofing and Insulation
204.66 Finish Hardware
204.67 Painting and Decorating
204.68 Waterproofing
204.69 Sprinklers and Fire Protection
204.7 Service Work
204.71 Electrical Work
204.72 Heating and Ventilating
204.73 Plumbing and Sewage
204.74 Air Conditioning
204.72 Fire Alarm, Telephone, Security, Miscellaneous
205 Paving, Curbs, Walks

415
 206 Installed Equipment (elevators, revolving doors, mailchutes, etc.)
207 Fencing

In developing or implementing a system of cost accounts, an appropriate

numbering or coding system is essential to facilitate communication of information
and proper aggregation of cost information. Particular cost accounts are used to
indicate the expenditures associated with specific projects and to indicate the
expenditures on particular items throughout an organization. These are examples of
different perspectives on the same information, in which the same information may
be summarized in different ways for specific purposes. Thus, more than one
aggregation of the cost information and more than one application program can use
a particular cost account. Separate identifiers of the type of cost account and the
specific project must be provided for project cost accounts or for financial
transactions. As a result, a standard set of cost codes such as the
MASTERFORMAT codes described in Chapter 9 may be adopted to identify cost
accounts along with project identifiers and extensions to indicate organization or
job specific needs. Similarly the use of databases or, at a minimum, inter-
communicating applications programs facilitate access to cost information, as
described in Chapter 14.

Converting a final cost estimate into a project budget compatible with an

organization's cost accounts is not always a straightforward task. As described in
Chapter 5, cost estimates are generally disaggregated into
appropriate functional or resource based project categories. For example, labor and
material quantities might be included for each of several physical components of a
project. For cost accounting purposes, labor and material quantities are aggregated
by type no matter for which physical component they are employed. For example,
particular types of workers or materials might be used on numerous different
physical components of a facility. Moreover, the categories of cost accounts
established within an organization may bear little resemblance to the quantities
included in a final cost estimate. This is particularly true when final cost estimates
are prepared in accordance with an external reporting requirement rather than in
view of the existing cost accounts within an organization.

One particular problem in forming a project budget in terms of cost accounts is the
treatment of contingency amounts. These allowances are included in project cost
estimates to accommodate unforeseen events and the resulting costs. However, in
advance of project completion, the source of contingency expenses is not known.
Realistically, a budget accounting item for contingency allowance should be
established whenever a contingency amount was included in the final cost estimate.

A second problem in forming a project budget is the treatment of inflation.

Typically, final cost estimates are formed in terms of real dollars and an item
reflecting inflation costs is added on as a percentage or lump sum. This inflation

416
allowance would then be allocated to individual cost items in relation to the actual
expected inflation over the period for which costs will be incurred.

Example 12-1: Project Budget for a Design Office

An example of a small project budget is shown in Table 12-2. This budget might be
used by a design firm for a specific design project. While this budget might
represent all the work for this firm on the project, numerous other organizations
would be involved with their own budgets. In Table 12-2, a summary budget is
shown as well as a detailed listing of costs for individuals in the Engineering
Division. For the purpose of consistency with cost accounts and managerial control,
labor costs are aggregated into three groups: the engineering, architectural and
environmental divisions. The detailed budget shown in Table 12-2 applies only to
the engineering division labor; other detailed budgets amounts for categories such
as supplies and the other work divisions would also be prepared. Note that the
salary costs associated with individuals are aggregated to obtain the total labor
costs in the engineering group for the project. To perform this aggregation, some
means of identifying individuals within organizational groups is required.
Accompanying a budget of this nature, some estimate of the actual man-hours of
labor required by project task would also be prepared. Finally, this budget might be
used for internal purposes alone. In submitting financial bills and reports to the
client, overhead and contingency amounts might be combined with the direct labor
costs to establish an aggregate billing rate per hour. In this case, the overhead,
contingency and profit would represent allocated costs based on the direct labor
costs.
TABLE 12-2 Example of a Small
Project Budget for a Design Firm
Budget
Personnel Summary
Architectural
Division $ 67,251.00
Engineering 45,372.00
Environmental 28,235.00
Division $140,858.00
Total

Other Direct 2,400.00

Expenses 1,500.00
Travel 600.00
Supplies 1,200.00
Communication $ 5,700.00
Computer
Services $ 175,869.60
Total
$ 95,700.00
Overhead
$ 418,127.60

417
 Contingency and
Profit

Total
Engineering
Personnel Detail
Senior Engineer
Associate Engineer $ 11,562.00
Engineer 21,365.00
Technician 12,654.00

Total $ 45,372.00

Example 12-2: Project Budget for a Constructor

Table 12-3 illustrates a summary budget for a constructor. This budget is developed
from a project to construct a wharf. As with the example design office budget
above, costs are divided into direct and indirect expenses. Within direct costs,
expenses are divided into material, subcontract, temporary work and machinery
costs. This budget indicates aggregate amounts for the various categories. Cost
details associated with particular cost accounts would supplement and support the
aggregate budget shown in Table 12-3. A profit and a contingency amount might
be added to the basic budget of $1,715,147 shown in Table 12-3 for completeness.
TABLE 12-3 An Example of a Project Budget for a Wharf Project (Amounts in Thousands of
Dollars)
Material Cost Subcontract Work Temporary Work Machinery Cost Total Cost
Steel Piling $292,172 $129,178 $16,389 $0 $437,739
Tie-rod 88,233 29,254 0 0 117,487
Anchor-Wall 130,281 60,873 0 0 191,154
Backfill 242,230 27,919 0 0 300,149
Coping 42,880 22,307 13,171 0 78,358
Dredging 0 111,650 0 0 111,650
Fender 48,996 10,344 0 1,750 61,090
Other 5,000 32,250 0 0 37,250
Sub-total $849,800 $423,775 $29,560 $1,750 $1,304,885
Summary
Total of direct cost $1,304,885
Indirect Cost
Common Temporary Work 19,320
Common Machinery 80,934
Transportation 15,550
Office Operating Costs 294,458
Total of Indirect Cost 410,262.
Total Project Cost $1,715,147

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Back to top

12.3 Forecasting for Activity Cost Control

For the purpose of project management and control, it is not sufficient to consider
only the past record of costs and revenues incurred in a project. Good managers
should focus upon future revenues, future costs and technical problems. For this
purpose, traditional financial accounting schemes are not adequate to reflect the
dynamic nature of a project. Accounts typically focus on recording routine costs
and past expenditures associated with activities. [4] Generally, past expenditures
represent sunk costs that cannot be altered in the future and may or may not be
relevant in the future. For example, after the completion of some activity, it may be
discovered that some quality flaw renders the work useless. Unfortunately, the
resources expended on the flawed construction will generally be sunk and cannot
be recovered for re-construction (although it may be possible to change the burden
of who pays for these resources by financial withholding or charges; owners will
typically attempt to have constructors or designers pay for changes due to quality
flaws). Since financial accounts are historical in nature, some means of forecasting
or projecting the future course of a project is essential for management control. In
this section, some methods for cost control and simple forecasts are described.

An example of forecasting used to assess the project status is shown in Table 12-4.
In this example, costs are reported in five categories, representing the sum of all the
various cost accounts associated with each category:

• Budgeted Cost
The budgeted cost is derived from the detailed cost estimate prepared at the
start of the project. Examples of project budgets were presented in Section
12.2. The factors of cost would be referenced by cost account and by a prose
description.
• Estimated total cost
The estimated or forecast total cost in each category is the current best
estimate of costs based on progress and any changes since the budget was
formed. Estimated total costs are the sum of cost to date, commitments and
exposure. Methods for estimating total costs are described below.
• Cost Committed and Cost Exposure!! Estimated cost to completion in
each category in divided into firm commitments and estimated additional
cost or exposure. Commitments may represent material orders or
subcontracts for which firm dollar amounts have been committed.
• Cost to Date
The actual cost incurred to date is recorded in column 6 and can be derived
from the financial record keeping accounts.

419
 • Over or (Under)
A final column in Table 12-4 indicates the amount over or under the budget
for each category. This column is an indicator of the extent of variance from
the project budget; items with unusually large overruns would represent a
particular managerial concern. Note that variance is used in the terminology
of project control to indicate a difference between budgeted and actual
expenditures. The term is defined and used quite differently in statistics or
mathematical analysis. In Table 12-4, labor costs are running higher than
expected, whereas subcontracts are less than expected.

The current status of the project is a forecast budget overrun of $5,950. with 23
percent of the budgeted project costs incurred to date.

TABLE 12-4 Illustration of a Job Status Report

Budgeted Estimated Cost Cost Cost To Over or
Factor Cost Total Cost Committed Exposure Date (Under)
Labor $99,406 $102,342 $49,596 --- $52,746 $2,936
Material 88,499 88,499 42,506 45,993 --- 0
Subcontracts 198,458 196,323 83,352 97,832 15,139 (2,135)
Equipment 37,543 37,543 23,623 --- 13,920 0
Other 72,693 81,432 49,356 --- 32,076 8,739
Total 496,509 506,139 248,433 143,825 113,881 5,950

For project control, managers would focus particular attention on items indicating
substantial deviation from budgeted amounts. In particular, the cost overruns in the
labor and in the "other expense category would be worthy of attention by a project
manager in Table 12-4. A next step would be to look in greater detail at the various
components of these categories. Overruns in cost might be due to lower than
expected productivity, higher than expected wage rates, higher than expected
material costs, or other factors. Even further, low productivity might be caused by
inadequate training, lack of required resources such as equipment or tools, or
inordinate amounts of re-work to correct quality problems. Review of a job status
report is only the first step in project control.

The job status report illustrated in Table 12-4 employs explicit estimates of
ultimate cost in each category of expense. These estimates are used to identify the
actual progress and status of a expense category. Estimates might be made from
simple linear extrapolations of the productivity or cost of the work to date on each
project item. Algebraically, a linear estimation formula is generally one of two
forms. Using a linear extrapolation of costs, the forecast total cost, Cf , is:

(12.1)

420
where Ct is the cost incurred to time t and pt is the proportion of the activity
completed at time t. For example, an activity which is 50 percent complete with a
cost of $40,000 would be estimated to have a total cost of $40,000/0.5 = $80,000.
More elaborate methods of forecasting costs would disaggregate costs into different
categories, with the total cost the sum of the forecast costs in each category.

Alternatively, the use of measured unit cost amounts can be used for forecasting
total cost. The basic formula for forecasting cost from unit costs is:

(12.2)

where Cf is the forecast total cost, W is the total units of work, and ct is the average
cost per unit of work experienced up to time t. If the average unit cost is $50 per
unit of work on a particular activity and 1,600 units of work exist, then the
expected cost is (1,600)(50) = $80,000 for completion.

The unit cost in Equation (12.2) may be replaced with the hourly productivity and
the unit cost per hour (or other appropriate time period), resulting in the equation:

(12.3)

where the cost per work unit (ct) is replaced by the time per unit, ht, divided by the
cost per unit of time, ut.

More elaborate forecasting systems might recognize peculiar problems associated

with work on particular items and modify these simple proportional cost estimates.
For example, if productivity is improving as workers and managers become more
familiar with the project activities, the estimate of total costs for an item might be
revised downward. In this case, the estimating equation would become:

(12.4)

where forecast total cost, Cf, is the sum of cost incurred to date, Ct, and the cost
resulting from the remaining work (W - Wt) multiplied by the expected cost per
unit time period for the remainder of the activity, ct.

As a numerical example, suppose that the average unit cost has been $50 per unit of
work, but the most recent figure during a project is $45 per unit of work. If the
project manager was assured that the improved productivity could be maintained
for the remainder of the project (consisting of 800 units of work out of a total of
1600 units of work), the cost estimate would be (50)(800) + (45)(800) = $76,000
for completion of the activity. Note that this forecast uses the actual average
productivity achieved on the first 800 units and uses a forecast of productivity for
the remaining work. Historical changes in productivity might also be used to

421
represent this type of non-linear changes in work productivity on particular
activities over time.

In addition to changes in productivities, other components of the estimating

formula can be adjusted or more detailed estimates substituted. For example, the
change in unit prices due to new labor contracts or material supplier's prices might
be reflected in estimating future expenditures. In essence, the same problems
encountered in preparing the detailed cost estimate are faced in the process of
preparing exposure estimates, although the number and extent of uncertainties in
the project environment decline as work progresses. The only exception to this rule
is the danger of quality problems in completed work which would require re-
construction.

Each of the estimating methods described above require current information on the
state of work accomplishment for particular activities. There are several possible
methods to develop such estimates, including [5]:

• Units of Work Completed

For easily measured quantities the actual proportion of completed work
amounts can be measured. For example, the linear feet of piping installed
can be compared to the required amount of piping to estimate the percentage
of piping work completed.
• Incremental Milestones
Particular activities can be sub-divided or "decomposed" into a series of
milestones, and the milestones can be used to indicate the percentage of
work complete based on historical averages. For example, the work effort
involved with installation of standard piping might be divided into four
milestones:
o Spool in place: 20% of work and 20% of cumulative work.
o Ends welded: 40% of work and 60% of cumulative work.
o Hangars and Trim Complete: 30% of work and 90% of cumulative
work.
o Hydrotested and Complete: 10% of work and 100% of cumulative
work.

Thus, a pipe section for which the ends have been welded would be reported
as 60% complete.

• Opinion
Subjective judgments of the percentage complete can be prepared by
inspectors, supervisors or project managers themselves. Clearly, this
estimated technique can be biased by optimism, pessimism or inaccurate
observations. Knowledgeable estimaters and adequate field observations are
required to obtain sufficient accuracy with this method.

422
 • Cost Ratio
The cost incurred to date can also be used to estimate the work progress. For
example, if an activity was budgeted to cost $20,000 and the cost incurred at
a particular date was $10,000, then the estimated percentage complete under
the cost ratio method would be 10,000/20,000 = 0.5 or fifty percent. This
method provides no independent information on the actual percentage
complete or any possible errors in the activity budget: the cost forecast will
always be the budgeted amount. Consequently, managers must use the
estimated costs to complete an activity derived from the cost ratio method
with extreme caution.

Systematic application of these different estimating methods to the various project

activities enables calculation of the percentage complete or the productivity
estimates used in preparing job status reports.

In some cases, automated data acquisition for work accomplishments might be

instituted. For example, transponders might be moved to the new work limits after
each day's activity and the new locations automatically computed and compared
with project plans. These measurements of actual progress should be stored in a
central database and then processed for updating the project schedule. The use of
database management systems in this fashion is described in Chapter 14.

Example 12-3: Estimated Total Cost to Complete an Activity

Suppose that we wish to estimate the total cost to complete piping construction
activities on a project. The piping construction involves 1,000 linear feet of piping
which has been divided into 50 sections for management convenience. At this time,
400 linear feet of piping has been installed at a cost of $40,000 and 500 man-hours
of labor. The original budget estimate was $90,000 with a productivity of one foot
per man-hour, a unit cost of $60 per man hour and a total material cost of $ 30,000.
Firm commitments of material delivery for the $30,000 estimated cost have been
received.

The first task is to estimate the proportion of work completed. Two estimates are
readily available. First, 400 linear feet of pipe is in place out of a total of 1000
linear feet, so the proportion of work completed is 400/1000 = 0.4 or 40%. This is
the "units of work completed" estimation method. Second, the cost ratio method
would estimate the work complete as the cost-to-date divided by the cost estimate
or $40,000/$ 90,000 = 0.44 or 44%. Third, the "incremental milestones" method
would be applied by examining each pipe section and estimating a percentage
complete and then aggregating to determine the total percentage complete. For
example, suppose the following quantities of piping fell into four categories of
completeness:

complete (100%) 380 ft

423
hangars and trim complete (90%) 20 ft
ends welded (60%) 5 ft
spool in place (20%) 0 ft

Then using the incremental milestones shown above, the estimate of completed
work would be 380 + (20)(0.9) + (5)(0.6) + 0 = 401 ft and the proportion complete
would be 401 ft/1,000 ft = 0.401 or 40% after rounding.

Once an estimate of work completed is available, then the estimated cost to

complete the activity can be calculated. First, a simple linear extrapolation of cost
results in an estimate of $40,000/0.4 = $100,000. for the piping construction using
the 40% estimate of work completed. This estimate projects a cost overrun of
100,000 - 90,000 = $10,000.

Second, a linear extrapolation of productivity results in an estimate of (1000 ft.)

(500 hrs/400 ft.)($60/hr) + 30,000 = $105,000. for completion of the piping
construction. This estimate suggests a variance of 105,000 - 90,000 = $15,000
above the activity estimate. In making this estimate, labor and material costs
entered separately, whereas the two were implicitly combined in the simple linear
cost forecast above. The source of the variance can also be identified in this
calculation: compared to the original estimate, the labor productivity is 1.25 hours
per foot or 25% higher than the original estimate.

Example 12-4: Estimated Total Cost for Completion

The forecasting procedures described above assumed linear extrapolations of future

costs, based either on the complete experience on the activity or the recent
experience. For activities with good historical records, it can be the case that a
typically non-linear profile of cost expenditures and completion proportions can be
estimated. Figure 12-1 illustrates one possible non-linear relationships derived from
experience in some particular activity. The progress on a new job can be compared
to this historical record. For example, point A in Figure 12-1 suggests a higher
expenditure than is normal for the completion proportion. This point represents
40% of work completed with an expenditure of 60% of the budget. Since the
historical record suggests only 50% of the budget should be expended at time of
40% completion, a 60 - 50 = 10% overrun in cost is expected even if work
efficiency can be increased to historical averages. If comparable cost overruns
continue to accumulate, then the cost-to-complete will be even higher.

424
Figure 12-1 Illustration of Proportion Completion versus Expenditure for an
Activity

Back to top

12.4 Financial Accounting Systems and Cost Accounts

The cost accounts described in the previous sections provide only one of the
various components in a financial accounting system. Before further discussing the
use of cost accounts in project control, the relationship of project and financial
accounting deserves mention. Accounting information is generally used for three
distinct purposes:

• Internal reporting to project managers for day-to-day planning, monitoring

and control.
• Internal reporting to managers for aiding strategic planning.
• External reporting to owners, government, regulators and other outside
parties.

External reports are constrained to particular forms and procedures by contractual

reporting requirements or by generally accepted accounting practices. Preparation
of such external reports is referred to as financial accounting. In

425
contrast, cost or managerial accounting is intended to aid internal managers in their
responsibilities of planning, monitoring and control.

Project costs are always included in the system of financial accounts associated
with an organization. At the heart of this system, all expense transactions are
recorded in a general ledger. The general ledger of accounts forms the basis for
management reports on particular projects as well as the financial accounts for an
entire organization. Other components of a financial accounting system include:

• The accounts payable journal is intended to provide records of bills

received from vendors, material suppliers, subcontractors and other outside
parties. Invoices of charges are recorded in this system as are checks issued
in payment. Charges to individual cost accounts are relayed or posted to the
General Ledger.
• Accounts receivable journals provide the opposite function to that of
accounts payable. In this journal, billings to clients are recorded as well as
receipts. Revenues received are relayed to the general ledger.
• Job cost ledgers summarize the charges associated with particular projects,
arranged in the various cost accounts used for the project budget.
• Inventory records are maintained to identify the amount of materials
available at any time.

In traditional bookkeeping systems, day to day transactions are first recorded in

journals. With double-entry bookkeeping, each transaction is recorded as both a
debit and a credit to particular accounts in the ledger. For example, payment of a
supplier's bill represents a debit or increase to a project cost account and a credit or
reduction to the company's cash account. Periodically, the transaction information
is summarized and transferred to ledger accounts. This process is called posting,
and may be done instantaneously or daily in computerized systems.

In reviewing accounting information, the concepts of flows and stocks should be

kept in mind. Daily transactions typically reflect flows of dollar amounts entering
or leaving the organization. Similarly, use or receipt of particular materials
represent flows from or to inventory. An account balance represents the stock or
cumulative amount of funds resulting from these daily flows. Information on both
flows and stocks are needed to give an accurate view of an organization's state. In
addition, forecasts of future changes are needed for effective management.

Information from the general ledger is assembled for the organization's financial
reports, including balance sheets and income statements for each period. These
reports are the basic products of the financial accounting process and are often used
to assess the performance of an organization. Table12-5 shows a typical income
statement for a small construction firm, indicating a net profit of $ 330,000 after
taxes. This statement summarizes the flows of transactions within a year. Table 12-
6 shows the comparable balance sheet, indicated a net increase in retained earnings

426
equal to the net profit. The balance sheet reflects the effects of income flows during
the year on the overall worth of the organization.

TABLE 12-5 Illustration of an Accounting Statement of Income

Income Statement
for the year ended December 31, 19xx
Gross project revenues $7,200,000

Direct project costs on contracts 5,500,000

Depreciation of equipment 200,000
Estimating 150,000
Administrative and other expenses 650,000
Subtotal of cost and expenses 6,500,000

Operating Income 700,000

Interest Expense, net 150,000
Income before taxes 550,000
Income tax 220,000
Net income after tax 330,000
Cash dividends 100,000
Retained earnings, current year 230,000
Retention at beginning of year 650,000
Retained earnings at end of year $880,000.

TABLE 12-6 Illustration of an Accounting Balance Sheet

Balance Sheet
December 31, 19xx
Assets Amount
Cash $150,000
Payments Receivable 750,000
Work in progress, not claimed 700,000
Work in progress, retention 200,000
Equipment at cost less accumulated depreciation 1,400,000
Total assets $3,200,000
Liabilities and Equity
Liabilities
Accounts payable $950,000
Other items payable (taxes, wages, etc.) 50,000
Long term debts 500,000
Subtotal 1,500,000
Shareholders' funds
40,000 shares of common stock
(Including paid-in capital) 820,000
Retained Earnings 880,000
Subtotal 1,700,000
Total Liabilities and Equity $3,200,000

427
In the context of private construction firms, particular problems arise in the
treatment of uncompleted contracts in financial reports. Under the "completed-
contract" method, income is only reported for completed projects. Work on projects
underway is only reported on the balance sheet, representing an asset if contract
billings exceed costs or a liability if costs exceed billings. When a project is
completed, the total net profit (or loss) is reported in the final period as income.
Under the "percentage-of-completion" method, actual costs are reported on the
income statement plus a proportion of all project revenues (or billings) equal to the
proportion of work completed during the period. The proportion of work completed
is computed as the ratio of costs incurred to date and the total estimated cost of the
project. Thus, if twenty percent of a project was completed in a particular period at
a direct cost of $180,000 and on a project with expected revenues of $1,000,000,
then the contract revenues earned would be calculated as $1,000,000(0.2) =
$200,000. This figure represents a profit and contribution to overhead of $200,000 -
$180,000 = $20,000 for the period. Note that billings and actual receipts might be
in excess or less than the calculated revenues of $200,000. On the balance sheet of
an organization using the percentage-of-completion method, an asset is usually
reported to reflect billings and the estimated or calculated earnings in excess of
actual billings.

As another example of the difference in the "percentage-of-completion" and the

"completed-contract" methods, consider a three year project to construct a plant
with the following cash flow for a contractor:

Year Contract Expenses Payments Received

1 $700,000 $900,000
2 180,000 250,000
3 320,000 150,000
Total $1,200,000 $1,300,000

The supervising architect determines that 60% of the facility is complete in year 1
and 75% in year 2. Under the "percentage-of-completion" method, the net income
in year 1 is $780,000 (60% of $1,300,000) less the $700,000 in expenses or
$80,000. Under the "completed-contract" method, the entire profit of $100,000
would be reported in year 3.

The "percentage-of-completion" method of reporting period earnings has the

advantage of representing the actual estimated earnings in each period. As a result,
the income stream and resulting profits are less susceptible to precipitate swings on
the completion of a project as can occur with the "completed contract method" of
calculating income. However, the "percentage-of-completion" has the disadvantage
of relying upon estimates which can be manipulated to obscure the actual position

428
of a company or which are difficult to reproduce by outside observers. There are
also subtleties such as the deferral of all calculated income from a project until a
minimum threshold of the project is completed. As a result, interpretation of the
income statement and balance sheet of a private organization is not always
straightforward. Finally, there are tax disadvantages from using the "percentage-of-
completion" method since corporate taxes on expected profits may become due
during the project rather than being deferred until the project completion. As an
example of tax implications of the two reporting methods, a study of forty-seven
construction firms conducted by the General Accounting Office found that $280
million in taxes were deferred from 1980 to 1984 through use of the "completed-
contract" method.[6]

It should be apparent that the "percentage-of-completion" accounting provides only

a rough estimate of the actual profit or status of a project. Also, the "completed
contract" method of accounting is entirely retrospective and provides no guidance
for management. This is only one example of the types of allocations that are
introduced to correspond to generally accepted accounting practices, yet may not
further the cause of good project management. Another common example is the use
of equipment depreciation schedules to allocate equipment purchase costs.
Allocations of costs or revenues to particular periods within a project may cause
severe changes in particular indicators, but have no real meaning for good
management or profit over the entire course of a project. As Johnson and Kaplan
argue: [7]

Today's management accounting information, driven by the procedures and cycle

of the organization's financial reporting system, is too late, too aggregated and too
distorted to be relevant for managers' planning and control decisions....

Management accounting reports are of little help to operating managers as they

attempt to reduce costs and improve productivity. Frequently, the reports decrease
productivity because they require operating managers to spend time attempting to
understand and explain reported variances that have little to do with the economic
and technological reality of their operations...

The managagement accounting system also fails to provide accurate product costs.
Cost are distributed to products by simplistic and arbitrary measures, usually direct
labor based, that do not represent the demands made by each product on the firm's
resources.

As a result, complementary procedures to those used in traditional financial

accounting are required to accomplish effective project control, as described in the
preceding and following sections. While financial statements provide consistent
and essential information on the condition of an entire organization, they need
considerable interpretation and supplementation to be useful for project
management.

429
Example 12-5: Calculating net profit

As an example of the calculation of net profit, suppose that a company began six
jobs in a year, completing three jobs and having three jobs still underway at the end
of the year. Details of the six jobs are shown in Table 12-7. What would be the
company's net profit under, first, the "percentage-of-completion" and, second, the
"completed contract method" accounting conventions?
TABLE 12-7 Example of Financial Records of Projects
Net Profit on Completed Contracts (Amounts in thousands of dollars)
Job 1 $1,436
Job 2 356
Job 3 - 738
Total Net Profit on Completed Jobs $1,054
Status of Jobs Underway Job 4 Job 5 Job 6
Original Contract Price $4,200 $3,800 $5,630
Contract Changes (Change Orders, etc.) 400 600 - 300
Total Cost to Date 3,600 1,710 620
Payments Received or Due to Date 3,520 1,830 340
Estimated Cost to Complete 500 2,300 5,000

As shown in Table 12-7, a net profit of $1,054,000 was earned on the three
completed jobs. Under the "completed contract" method, this total would be total
profit. Under the percentage-of completion method, the year's expected profit on
the projects underway would be added to this amount. For job 4, the expected
profits are calculated as follows:

Current contract price = Original contract price + Contract Changes

= 4,200 + 400 + 4,600
Credit or debit to date = Total costs to date - Payments received or due to date
= 3,600 - 3,520 = - 80
Contract value of uncompleted = Current contract price - Payments received or due
work = 4,600 - 3,520 = 1,080
Credit or debit to come = Contract value of uncompleted work - Estimated Cost to
Complete
= 1,080 - 500 = 580
Estimated final gross profit = Credit or debit to date + Credit or debit to come
= - 80. + 580. = 500
Estimated total project costs = Contract price - Gross profit
= 4,600 - 500 = 4,100
Estimated Profit to date = Estimated final gross profit x Proportion of work complete
= 500. (3600/4100)) = 439

Similar calculations for the other jobs underway indicate estimated profits to date
of $166,000 for Job 5 and -$32,000 for Job 6. As a result, the net profit using the
"percentage-of-completion" method would be $1,627,000 for the year. Note that

430
this figure would be altered in the event of multi-year projects in which net profits
on projects completed or underway in this year were claimed in earlier periods.

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12.5 Control of Project Cash Flows

Section 12.3 described the development of information for the control of project
costs with respect to the various functional activities appearing in the project
budget. Project managers also are involved with assessment of the overall status of
the project, including the status of activities, financing, payments and receipts.
These various items comprise the project and financing cash flows described in
earlier chapters. These components include costs incurred (as described above),
billings and receipts for billings to owners (for contractors), payable amounts to
suppliers and contractors, financing plan cash flows (for bonds or other financial
instruments), etc.

As an example of cash flow control, consider the report shown in Table 12-8. In
this case, costs are not divided into functional categories as in Table 12-4, such as
labor, material, or equipment. Table 12-8 represents a summary of the project status
as viewed from different components of the accounting system. Thus, the
aggregation of different kinds of cost exposure or cost commitment shown in Table
12-0 has not been performed. The elements in Table 12-8 include:

• Costs
This is a summary of charges as reflected by the job cost accounts, including
expenditures and estimated costs. This row provides an aggregate summary
of the detailed activity cost information described in the previous section.
For this example, the total costs as of July 2 (7/02) were $ 8,754,516, and the
original cost estimate was $65,863,092, so the approximate percentage
complete was 8,754,516/65,863,092 or 13.292%. However, the project
manager now projects a cost of $66,545,263 for the project, representing an
increase of $682,171 over the original estimate. This new estimate would
reflect the actual percentage of work completed as well as other effects such
as changes in unit prices for labor or materials. Needless to say, this increase
in expected costs is not a welcome change to the project manager.
• Billings
This row summarizes the state of cash flows with respect to the owner of the
facility; this row would not be included for reports to owners. The contract
amount was $67,511,602, and a total of $9,276,621 or 13.741% of the
contract has been billed. The amount of allowable billing is specified under
the terms of the contract between an owner and an engineering, architect, or
constructor. In this case, total billings have exceeded the estimated project
completion proportion. The final column includes the currently projected net
earnings of $966,339. This figure is calculated as the contract amount less

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 projected costs: 67,511,602 - 66,545,263 = $966,339. Note that this profit
figure does not reflect the time value of money or discounting.
• Payables
The Payables row summarizes the amount owed by the contractor to material
suppliers, labor or sub-contractors. At the time of this report, $6,719,103 had
been paid to subcontractors, material suppliers, and others. Invoices of
$1,300,089 have accumulated but have not yet been paid. A retention of
$391,671 has been imposed on subcontractors, and $343,653 in direct labor
expenses have been occurred. The total of payables is equal to the total
project expenses shown in the first row of costs.
• Receivables
This row summarizes the cash flow of receipts from the owner. Note that the
actual receipts from the owner may differ from the amounts billed due to
delayed payments or retainage on the part of the owner. The net-billed
equals the gross billed less retention by the owner. In this case, gross billed
is $9,276,621 (as shown in the billings row), the net billed is $8,761,673 and
the retention is $514,948. Unfortunately, only $7,209,344 has been received
from the owner, so the open receivable amount is a (substantial!) $2,067,277
due from the owner.
• Cash Position
This row summarizes the cash position of the project as if all expenses and
receipts for the project were combined in a single account. The actual
expenditures have been $7,062,756 (calculated as the total costs of
$8,754,516 less subcontractor retentions of $391,671 and unpaid bills of
$1,300,089) and $ 7,209,344 has been received from the owner. As a result,
a net cash balance of $146,588 exists which can be used in an interest
earning bank account or to finance deficits on other projects.

Each of the rows shown in Table 12-8 would be derived from different sets of
financial accounts. Additional reports could be prepared on the financing cash
flows for bonds or interest charges in an overdraft account.

TABLE 12-8 An Example of a Cash Flow Status Report

Costs Charges Estimated % Complete Projected Change
7/02 8,754,516 65,863,092 13.292 66,545,263 682,171
Billings Contract Gross Bill % Billed Profit
7/01 67,511,602 9,276,621 13.741 966,339

Payables Paid Open Retention Labor Total

7/01 6,719,103 1,300,089 391,671 343,653 8,754,516
Receivable Net Bill Received Retention Open
7/02 8,761,673 7,209,344 514,948 2,067,277
Cash Position Paid Received Position
7,062,756 7,209,344 146,588

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The overall status of the project requires synthesizing the different pieces of
information summarized in Table 12-8. Each of the different accounting systems
contributing to this table provides a different view of the status of the project. In
this example, the budget information indicates that costs are higher than expected,
which could be troubling. However, a profit is still expected for the project. A
substantial amount of money is due from the owner, and this could turn out to be a
problem if the owner continues to lag in payment. Finally, the positive cash
position for the project is highly desirable since financing charges can be avoided.

The job status reports illustrated in this and the previous sections provide a primary
tool for project cost control. Different reports with varying amounts of detail and
item reports would be prepared for different individuals involved in a project.
Reports to upper management would be summaries, reports to particular staff
individuals would emphasize their responsibilities (eg. purchasing, payroll, etc.),
and detailed reports would be provided to the individual project managers. Coupled
with scheduling reports described in Chapter 10, these reports provide a snapshot
view of how a project is doing. Of course, these schedule and cost reports would
have to be tempered by the actual accomplishments and problems occurring in the
field. For example, if work already completed is of sub-standard quality, these
reports would not reveal such a problem. Even though the reports indicated a
project on time and on budget, the possibility of re-work or inadequate facility
performance due to quality problems would quickly reverse that rosy situation.

Back to top

12.6 Schedule Control

In addition to cost control, project managers must also give considerable attention
to monitoring schedules. Construction typically involves a deadline for work
completion, so contractual agreements will force attention to schedules. More
generally, delays in construction represent additional costs due to late facility
occupancy or other factors. Just as costs incurred are compared to budgeted costs,
actual activity durations may be compared to expected durations. In this process,
forecasting the time to complete particular activities may be required.

The methods used for forecasting completion times of activities are directly
analogous to those used for cost forecasting. For example, a typical estimating
formula might be:

(12.5)

where Df is the forecast duration, W is the amount of work, and ht is the observed
productivity to time t. As with cost control, it is important to devise efficient and

433
cost effective methods for gathering information on actual project
accomplishments. Generally, observations of work completed are made by
inspectors and project managers and then work completed is estimated as described
in Section 12.3. Once estimates of work complete and time expended on particular
activities is available, deviations from the original duration estimate can be
estimated. The calculations for making duration estimates are quite similar to those
used in making cost estimates in Section 12.3.

For example, Figure 12-2 shows the originally scheduled project progress versus
the actual progress on a project. This figure is constructed by summing up the
percentage of each activity which is complete at different points in time; this
summation can be weighted by the magnitude of effort associated with each
activity. In Figure 12-2, the project was ahead of the original schedule for a period
including point A, but is now late at point B by an amount equal to the horizontal
distance between the planned progress and the actual progress observed to date.

Figure 12-2 Illustration of Planned versus Actual Progress over Time on a Project

Schedule adherence and the current status of a project can also be represented on
geometric models of a facility. For example, an animation of the construction
sequence can be shown on a computer screen, with different colors or other coding
scheme indicating the type of activity underway on each component of the facility.

434
Deviations from the planned schedule can also be portrayed by color coding. The
result is a mechanism to both indicate work in progress and schedule adherence
specific to individual components in the facility.

In evaluating schedule progress, it is important to bear in mind that some activities

possess float or scheduling leeway, whereas delays in activities on the critical path
will cause project delays. In particular, the delay in planned progress at time t may
be soaked up in activities' float (thereby causing no overall delay in the project
completion) or may cause a project delay. As a result of this ambiguity, it is
preferable to update the project schedule to devise an accurate protrayal of the
schedule adherence. After applying a scheduling algorithm, a new project schedule
can be obtained. For cash flow planning purposes, a graph or report similar to that
shown in Figure 12-3 can be constructed to compare actual expenditures to planned
expenditures at any time. This process of re-scheduling to indicate the schedule
adherence is only one of many instances in which schedule and budget updating
may be appropriate, as discussed in the next section.

Figure 12-3 Illustration of Planned versus Actual Expenditures on a Project

Back to top

12.7 Schedule and Budget Updates

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Scheduling and project planning is an activity that continues throughout the
lifetime of a project. As changes or discrepancies between the plan and the
realization occur, the project schedule and cost estimates should be modified and
new schedules devised. Too often, the schedule is devised once by a planner in the
central office, and then revisions or modifications are done incompletely or only
sporadically. The result is the lack of effective project monitoring and the
possibility of eventual chaos on the project site.

On "fast track" projects, initial construction activities are begun even before the
facility design is finalized. In this case, special attention must be placed on the
coordinated scheduling of design and construction activities. Even in projects for
which the design is finalized before construction begins, change
orders representing changes in the "final" design are often issued to incorporate
changes desired by the owner.

Periodic updating of future activity durations and budgets is especially important to

avoid excessive optimism in projects experiencing problems. If one type of activity
experiences delays on a project, then related activities are also likely to be delayed
unless managerial changes are made. Construction projects normally involve
numerous activities which are closely related due to the use of similar materials,
equipment, workers or site characteristics. Expected cost changes should also be
propagated thoughout a project plan. In essence, duration and cost estimates for
future activities should be revised in light of the actual experience on the job.
Without this updating, project schedules slip more and more as time progresses. To
perform this type of updating, project managers need access to original estimates
and estimating assumptions.

Unfortunately, most project cost control and scheduling systems do not provide
many aids for such updating. What is required is a means of identifying
discrepancies, diagnosing the cause, forecasting the effect, and propagating this
effect to all related activities. While these steps can be undertaken manually,
computers aids to support interactive updating or even automatic updating would
be helpful. [8]

Beyond the direct updating of activity durations and cost estimates, project
managers should have mechanisms available for evaluating any type of schedule
change. Updating activity duration estimations, changing scheduled start times,
modifying the estimates of resources required for each activity, and even changing
the project network logic (by inserting new activities or other changes) should all
be easily accomplished. In effect, scheduling aids should be directly available to
project managers. [9] Fortunately, local computers are commonly available on site
for this purpose.

Example 12-6: Schedule Updates in a Small Project

436
As an example of the type of changes that might be required, consider the nine
activity project described in Section 10.3 and appearing in Figure 12-4. Also,
suppose that the project is four days underway, with the current activity schedule
and progress as shown in Figure 12-5. A few problems or changes that might be
encountered include the following:

1. An underground waterline that was previously unknown was ruptured during

the fifth day of the project. An extra day was required to replace the ruptured
section, and another day will be required for clean-up. What is the impact on
the project duration?
o To analyze this change with the critical path scheduling procedure, the
manager has the options of (1) changing the expected duration of
activity C, General Excavation, to the new expected duration of 10
days or (2) splitting activity C into two tasks (corresponding to the
work done prior to the waterline break and that to be done after) and
adding a new activity representing repair and clean-up from the
waterline break. The second approach has the advantage that any
delays to other activities (such as activities D and E) could also be
indicated by precedence constraints.
o Assuming that no other activities are affected, the manager decides to
increase the expected duration of activity C to 10 days. Since activity
C is on the critical path, the project duration also increases by 2 days.
Applying the critical path scheduling procedure would confirm this
change and also give a new set of earliest and latest starting times for
the various activities.
2. After 8 days on the project, the owner asks that a new drain be installed in
addition to the sewer line scheduled for activity G. The project manager
determines that a new activity could be added to install the drain in parallel
with Activity G and requiring 2 days. What is the effect on the schedule?
o Inserting a new activity in the project network between nodes 3 and 4
violates the activity-on-branch convention that only one activity can
be defined between any two nodes. Hence, a new node and a dummy
activity must be inserted in addition to the drain installation activity.
As a result, the nodes must be re-numbered and the critical path
schedule developed again. Performing these operations reveals that no
change in the project duration would occur and the new activity has a
total float of 1 day.
o To avoid the labor associated with modifying the network and re-
numbering nodes, suppose that the project manager simply re-defined
activity G as installation of sewer and drain lines requiring 4 days. In
this case, activity G would appear on the critical path and the project
duration would increase. Adding an additional crew so that the two
installations could proceed in parallel might reduce the duration of
activity G back to 2 days and thereby avoid the increase in the project
duration.

437
 3. At day 12 of the project, the excavated trenches collapse during Activity E.
An additional 5 days will be required for this activity. What is the effect on
the project schedule? What changes should be made to insure meeting the
completion deadline?
o Activity E has a total float of only 1 day. With the change in this
activity's duration, it will lie on the critical path and the project
duration will increase.
o Analysis of possible time savings in subsequent activities is now
required, using the procedures described in Section 10.9.

Figure 12-4 A Nine Activity Example Project

438
Figure 12-5 Current Schedule for an Example Project Presented as a Bar Chart

As can be imagined, it is not at all uncommon to encounter changes during the

course of a project that require modification of durations, changes in the network
logic of precedence relationships, or additions and deletions of activities.
Consequently, the scheduling process should be readily available as the project is
underway.

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12.8 Relating Cost and Schedule Information

The previous sections focused upon the identification of the budgetary and
schedule status of projects. Actual projects involve a complex inter-relationship

439
between time and cost. As projects proceed, delays influence costs and budgetary
problems may in turn require adjustments to activity schedules. Trade-offs between
time and costs were discussed in Section 10.9 in the context of project planning in
which additional resources applied to a project activity might result in a shorter
duration but higher costs. Unanticipated events might result in increases in both
time and cost to complete an activity. For example, excavation problems may
easily lead to much lower than anticipated productivity on activities requiring
digging.

While project managers implicitly recognize the inter-play between time and cost
on projects, it is rare to find effective project control systems which include both
elements. Usually, project costs and schedules are recorded and reported by
separate application programs. Project managers must then perform the tedious task
of relating the two sets of information.

The difficulty of integrating schedule and cost information stems primarily from
the level of detail required for effective integration. Usually, a single project
activity will involve numerous cost account categories. For example, an activity for
the preparation of a foundation would involve laborers, cement workers, concrete
forms, concrete, reinforcement, transportation of materials and other resources.
Even a more disaggregated activity definition such as erection of foundation forms
would involve numerous resources such as forms, nails, carpenters, laborers, and
material transportation. Again, different cost accounts would normally be used to
record these various resources. Similarly, numerous activities might involve
expenses associated with particular cost accounts. For example, a particular
material such as standard piping might be used in numerous different schedule
activities. To integrate cost and schedule information, the disaggregated charges for
specific activities and specific cost accounts must be the basis of analysis.

A straightforward means of relating time and cost information is to define

individual work elements representing the resources in a particular cost category
associated with a particular project activity. Work elements would represent an
element in a two-dimensional matrix of activities and cost accounts as illustrated in
Figure 12-6. A numbering or identifying system for work elements would include
both the relevant cost account and the associated activity. In some cases, it might
also be desirable to identify work elements by the responsible organization or
individual. In this case, a three dimensional representation of work elements is
required, with the third dimension corresponding to responsible
individuals. [10] More generally, modern computerized databases can accomadate
a flexible structure of data representation to support aggregation with respect to
numerous different perspectives; this type of system will be discussed in Chapter
14.

With this organization of information, a number of management reports or views

could be generated. In particular, the costs associated with specific activities could

440
be obtained as the sum of the work elements appearing in any row in Figure 12-6.
These costs could be used to evaluate alternate technologies to accomplish
particular activities or to derive the expected project cash flow over time as the
schedule changes. From a management perspective, problems developing from
particular activities could be rapidly identified since costs would be accumulated at
such a disaggregated level. As a result, project control becomes at once more
precise and detailed.

Figure 12-6 Illustration of a Cost Account and Project Activity Matrix

Unfortunately, the development and maintenance of a work element database can

represent a large data collection and organization effort. As noted earlier, four
hundred separate cost accounts and four hundred activities would not be unusual
for a construction project. The result would be up to 400x400 = 160,000 separate
work elements. Of course, not all activities involve each cost account. However,
even a density of two percent (so that each activity would have eight cost accounts
and each account would have eight associated activities on the average) would
involve nearly thirteen thousand work elements. Initially preparing this database
represents a considerable burden, but it is also the case that project bookkeepers
must record project events within each of these various work elements.
Implementations of the "work element" project control systems have typically
fondered on the burden of data collection, storage and book-keeping.

Until data collection is better automated, the use of work elements to control
activities in large projects is likely to be difficult to implement. However, certain
segments of project activities can profit tremendously from this type of
organization. In particular, material requirements can be tracked in this fashion.
Materials involve only a subset of all cost accounts and project activities, so the
burden of data collection and control is much smaller than for an entire system.
Moreover, the benefits from integration of schedule and cost information are
particularly noticeable in materials control since delivery schedules are directly

441
affected and bulk order discounts might be identified. Consequently, materials
control systems can reasonably encompass a "work element" accounting system.

In the absence of a work element accounting system, costs associated with

particular activities are usually estimated by summing expenses in all cost accounts
directly related to an activity plus a proportion of expenses in cost accounts used
jointly by two or more activities. The basis of cost allocation would typically be the
level of effort or resource required by the different activities. For example, costs
associated with supervision might be allocated to different concreting activities on
the basis of the amount of work (measured in cubic yards of concrete) in the
different activities. With these allocations, cost estimates for particular work
activities can be obtained.

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12.9 References
1. American Society of Civil Engineers, "Construction Cost Control," ASCE
Manuals and Reports of Engineering Practice No. 65, Rev. Ed., 1985.
2. Coombs, W.E. and W.J. Palmer, Construction Accounting and Financial
Management, McGraw-Hill, New York, 1977.
3. Halpin, D. W., Financial and Cost Concepts for Construction Management,
John Wiley & Sons, New York, 1985.
4. Johnson, H. Thomas and Robert S. Kaplan, Relevance Lost, The Rise and
Fall of Management Accounting, Harvard Business School Press, Boston,
MA 1987.
5. Mueller, F.W. Integrated Cost and Schedule Control for Construction
Projects, Van Nostrand Reinhold Company, New York, 1986.
6. Tersine, R.J., Principles of Inventory and Materials Management, North
Holland, 1982.

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12.10 Problems
1. Suppose that the expected expenditure of funds in a particular category was
expected to behave in a piecewise linear fashion over the course of the
project. In particular, the following points have been established from
historical records for the percentage of completion versus the expected
expenditure (as a percentage of the budget):

Percentage of Completion Expected Expenditure

442
 0% 0%
20% 10%
40% 25%
60% 55%
80% 90%
100% 100%

a. Graph the relationship between percentage complete and expected

expenditure.
b. Develop a formula or set of formulas for forecasting the ultimate
expenditure on this activity given the percentage of completion. Assume that
any over or under expenditure will continue to grow proportionately during
the course of the project.
c. Using your formula, what is the expected expenditure as a percentage of
the activity budget if:
i. 15% of funds have been expended and 15% of the activity is complete.
ii. 30% of funds have been expended and 30% of the activity is complete.
iii. 80% of funds have been expended and 80% of the activity is complete.

2. Repeat Problem 1 parts (b) and (c) assuming that any over or under
expenditure will not continue to grow during the course of the project.

3. Suppose that you have been asked to take over as project manager on a small
project involving installation of 5,000 linear feet (LF) of metal ductwork in a
building. The job was originally estimated to take ten weeks, and you are
assuming your duties after three weeks on the project. The original estimate
assumed that each linear foot of ductwork would cost $10, representing $6 in
labor costs and $4 in material cost. The expected production rate was 500
linear feet of ductwork per week. Appearing below is the data concerning
this project available from your firm's job control information system:

Weekly Unit Costs ($/Lf) Quantity Placed (Lf) Total Cost

Week Labor Materials Total Week To Date Week To Date
1 12.00 4.00 16.00 250 250 4,000 4,000
2 8.57 4.00 12.57 350 600 4,400 8,400
3 6.67 4.00 10.67 450 1,050 4,800 13,200

a. Based on an extrapolation using the average productivity and cost for all
three weeks, forecast the completion time, cost and variance from original
estimates.
b. Suppose that you assume that the productivity achieved in week 3 would

443
 continue for the remainder of the project. How would this affect your
forecasts in (a)? Prepare new forecasts based on this assumption.

4. What criticisms could you make of the job status report in the previous
problem from the viewpoint of good project management?

5. Suppose that the following estimate was made for excavation of 120,000
cubic yards on a site:

Resource Quantity Cost

Machines 1,200 hours $60,000
Labor 6,000 hours 150,000
Trucks 2,400 hours 75,000
Total $285,000

After 95,000 cubic yards of excavation was completed, the following

expenditures had been recorded:

Resource Quantity Cost

Machines 1,063 hours $47,835
Labor 7,138 hours 142,527
Trucks 1,500 hours 46,875
Total $237,237

a. Calculate estimated and experienced productivity (cubic yards per hour)

and unit cost (cost per cubic yard) for each resource.
b. Based on straight line extrapolation, do you see any problem with this
activity? If so, can you suggest a reason for the problem based on your
findings in (a)?

6. Suppose the following costs and units of work completed were recorded on
an activity:

Monthly Number of
Month Expenditure Work Units Completed
1 $1,200 30
2 $1,250 32

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 3 $1,260 38
4 $1,280 42
5 $1,290 42
6 $1,280 42

Answer the following questions:

a. For each month, determine the cumulative cost, the cumulative work
completed, the average cumulative cost per unit of work, and the monthly
cost per unit of work.
b. For each month, prepare a forecast of the eventual cost-to-complete the
activity based on the proportion of work completed.
c. For each month, prepare a forecast of the eventual cost-to-complete the
activity based on the average productivity experienced on the activity.
d. For each month, prepare a forecast of the eventual cost-to-complete the
activity based on the productivity experienced in the previous month.
e. Which forecasting method (b, c or d) is preferable for this activity? Why?

7. Repeat Problem 6 for the following expenditure pattern:

Monthly Number of
Month Expenditure Work Units Completed
1 $1,200 30
2 $1,250 35
3 $1,260 45
4 $1,280 48
5 $1,290 52
6 $1,300 54

8. Why is it difficult to integrate scheduling and cost accounting information in

project records?

9. Prepare a schedule progress report on planned versus actual expenditure on a

project (similar to that in Figure 12-5) for the project described in Example
12-6.

10.Suppose that the following ten activities were agreed upon in a contract
between an owner and an engineer.

445
 Original Work Plan Information
Activity Duration (months) Predecessors Estimated Cost ($ thousands)
A 2 --- 7
B 5 --- 9
C 5 B 8
D 2 C 4
E 3 B 1
F 8 --- 7
G 4 E, F6
H 4 E, F5
I 11 B 10
J 2 E, F 7
Original Contract Information
Total Direct Cost $64
Overhead 64
Total Direct and Overhead 128
Profit 12.8
Total Contract Amount $140.8
First Year Cash Flow
Expenditures $56,000
Receipts $60,800

The markup on the activities' costs included 100% overhead and a profit of
10% on all costs (including overhead). This job was suspended for one year
after completion of the first four activities, and the owner paid a total of
$60,800 to the engineer. Now the owner wishes to re-commence the job.
However, general inflation has increased costs by ten percent in the
intervening year. The engineer's discount rate is 15 percent per year (in
current year dollars). For simplicity, you may assume that all cash
transactions occur at the end of the year in making discounting calculations
in answering the following questions:

a. How long will be remaining six activities require?

b. Suppose that the owner agrees to make a lump sum payment of the
remaining original contract at the completion of the project. Would the
engineer still make a profit on the job? If so, how much?
c. Given that the engineer would receive a lump sum payment at the end of
the project, what amount should he request in order to earn his desired ten
percent profit on all costs?
d. What is the net future value of the entire project at the end, assuming that
the lump sum payment you calculated in (c) is obtained?

446
 11.Based on your knowledge of coding systems such as MASTERFORMAT
and estimating techniques, outline the procedures that might be implemented
to accomplish:

a. automated updating of duration and cost estimates of activities in light of

experience on earlier, similar activities.
b. interactive computer based aids to help a project manager to accomplish
the same task.

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12.11 Footnotes
1. Cited in Zoll, Peter F., "Database Structures for Project
Management," Proceedings of the Seventh Conference on Electronic
Computation, ASCE, 1979. Back

2. Thomas Gibb reports a median number of 400 cost accounts for a two-million
dollar projects in a sample of 30 contractors in 1975. See T.W. Gibb, Jr., "Building
Construction in Southeastern United States," School of Civil Engineering, Georgia
Institute of Technology, 1975, reported in D.W. Halpin, Financial and Cost
Concepts for Construction Management, John Wiley and Sons, 1985. Back

3. This illustrative set of accounts was adapted from an ASCE Manual of

Practice: Construction Cost Control, Task Committee on Revision of Construction
Cost Control Manual, ASCE, New York, 1985. Back

4. For a fuller exposition of this point, see W.H. Lucas and T.L. Morrison,
"Management Accounting for Construction Contracts," Management Accounting,
1981, pp. 59-65. Back

5. For a description of these methods and examples as used by a sample of

construction companies, see L.S. Riggs, Cost and Schedule Control in Industrial
Construction, Report to The Construction Industry Institute, Dec. 1986. Back

6. As reported in the Wall Street Journal, Feb. 19, 1986, pg. A1, c. 4. Back

7. H.T. Johnson and R.S. Kaplan, Relevance Lost, The Rise and Fall of
Management Accounting, Harvard Business School Press, pg. 1, 1987. Back

8. One experimental program directed at this problem is a knowledge based expert

system described in R.E. Levitt and J.C. Kunz, "Using Knowledge of Construction
and Project Management for Automated Schedule Updating," Project Management
Journal, Vol. 16, 1985, pp. 57-76. Back

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9. For an example of a prototype interactive project management environment that
includes graphical displays and scheduling algorithms, see R. Kromer, "Interactive
Activity Network Analysis Using a Personal Computer," Unpublished MS Thesis,
Department of Civil Engineering, Carnegie-Mellon University, Pittsburgh, PA,
1984. Back

10. A three dimensional work element definition was proposed by J.M. Neil, "A
System for Integrated Project Management," Proceedings of the Conference on
Current Practice in Cost Estimating and Cost Control, ASCE, Austin, Texas, 138-
146, April 1983. Back

448
13. Quality Control and Safety During
Construction
13.1 Quality and Safety Concerns in Construction
Quality control and safety represent increasingly important concerns for project
managers. Defects or failures in constructed facilities can result in very large costs.
Even with minor defects, re-construction may be required and facility operations
impaired. Increased costs and delays are the result. In the worst case, failures may
cause personal injuries or fatalities. Accidents during the construction process can
similarly result in personal injuries and large costs. Indirect costs of insurance,
inspection and regulation are increasing rapidly due to these increased direct costs.
Good project managers try to ensure that the job is done right the first time and that
no major accidents occur on the project.

As with cost control, the most important decisions regarding the quality of a
completed facility are made during the design and planning stages rather than
during construction. It is during these preliminary stages that component
configurations, material specifications and functional performance are decided.
Quality control during construction consists largely of insuring conformance to
these original design and planning decisions.

While conformance to existing design decisions is the primary focus of quality

control, there are exceptions to this rule. First, unforeseen circumstances, incorrect
design decisions or changes desired by an owner in the facility function may
require re-evaluation of design decisions during the course of construction. While
these changes may be motivated by the concern for quality, they represent
occasions for re-design with all the attendant objectives and constraints. As a
second case, some designs rely upon informed and appropriate decision making
during the construction process itself. For example, some tunneling methods make
decisions about the amount of shoring required at different locations based upon
observation of soil conditions during the tunneling process. Since such decisions
are based on better information concerning actual site conditions, the facility design
may be more cost effective as a result. Any special case of re-design during
construction requires the various considerations discussed in Chapter 3.

With the attention to conformance as the measure of quality during the construction
process, the specification of quality requirements in the design and contract
documentation becomes extremely important. Quality requirements should be clear
and verifiable, so that all parties in the project can understand the requirements for
conformance. Much of the discussion in this chapter relates to the development and

449
the implications of different quality requirements for construction as well as the
issues associated with insuring conformance.

Safety during the construction project is also influenced in large part by decisions
made during the planning and design process. Some designs or construction plans
are inherently difficult and dangerous to implement, whereas other, comparable
plans may considerably reduce the possibility of accidents. For example, clear
separation of traffic from construction zones during roadway rehabilitation can
greatly reduce the possibility of accidental collisions. Beyond these design
decisions, safety largely depends upon education, vigilance and cooperation during
the construction process. Workers should be constantly alert to the possibilities of
accidents and avoid taken unnecessary risks.

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13.2 Organizing for Quality and Safety

A variety of different organizations are possible for quality and safety control
during construction. One common model is to have a group responsible for quality
assurance and another group primarily responsible for safety within an
organization. In large organizations, departments dedicated to quality assurance and
to safety might assign specific individuals to assume responsibility for these
functions on particular projects. For smaller projects, the project manager or an
assistant might assume these and other responsibilities. In either case, insuring safe
and quality construction is a concern of the project manager in overall charge of the
project in addition to the concerns of personnel, cost, time and other management
issues.

Inspectors and quality assurance personnel will be involved in a project to represent

a variety of different organizations. Each of the parties directly concerned with the
project may have their own quality and safety inspectors, including the owner, the
engineer/architect, and the various constructor firms. These inspectors may be
contractors from specialized quality assurance organizations. In addition to on-site
inspections, samples of materials will commonly be tested by specialized
laboratories to insure compliance. Inspectors to insure compliance with regulatory
requirements will also be involved. Common examples are inspectors for the local
government's building department, for environmental agencies, and for
occupational health and safety agencies.

The US Occupational Safety and Health Administration (OSHA) routinely

conducts site visits of work places in conjunction with approved state inspection
agencies. OSHA inspectors are required by law to issue citations for all standard
violations observed. Safety standards prescribe a variety of mechanical safeguards
and procedures; for example, ladder safety is covered by over 140 regulations. In
cases of extreme non-compliance with standards, OSHA inspectors can stop work

450
on a project. However, only a small fraction of construction sites are visited by
OSHA inspectors and most construction site accidents are not caused by violations
of existing standards. As a result, safety is largely the responsibility of the
managers on site rather than that of public inspectors.

While the multitude of participants involved in the construction process require the
services of inspectors, it cannot be emphasized too strongly that inspectors are only
a formal check on quality control. Quality control should be a primary objective for
all the members of a project team. Managers should take responsibility for
maintaining and improving quality control. Employee participation in quality
control should be sought and rewarded, including the introduction of new ideas.
Most important of all, quality improvement can serve as a catalyst for improved
productivity. By suggesting new work methods, by avoiding rework, and by
avoiding long term problems, good quality control can pay for itself. Owners
should promote good quality control and seek out contractors who maintain such
standards.

In addition to the various organizational bodies involved in quality control, issues

of quality control arise in virtually all the functional areas of construction activities.
For example, insuring accurate and useful information is an important part of
maintaining quality performance. Other aspects of quality control include
document control (including changes during the construction process),
procurement, field inspection and testing, and final checkout of the facility.

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13.3 Work and Material Specifications

Specifications of work quality are an important feature of facility designs.
Specifications of required quality and components represent part of the necessary
documentation to describe a facility. Typically, this documentation includes any
special provisions of the facility design as well as references to generally accepted
specifications to be used during construction.

General specifications of work quality are available in numerous fields and are
issued in publications of organizations such as the American Society for Testing
and Materials (ASTM), the American National Standards Institute (ANSI), or the
Construction Specifications Institute (CSI). Distinct specifications are formalized
for particular types of construction activities, such as welding standards issued by
the American Welding Society, or for particular facility types, such as the Standard
Specifications for Highway Bridges issued by the American Association of State
Highway and Transportation Officials. These general specifications must be
modified to reflect local conditions, policies, available materials, local regulations
and other special circumstances.

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Construction specifications normally consist of a series of instructions or
prohibitions for specific operations. For example, the following passage illustrates
a typical specification, in this case for excavation for structures:

Conform to elevations and dimensions shown on plan within a tolerance of plus or

minus 0.10 foot, and extending a sufficient distance from footings and foundations
to permit placing and removal of concrete formwork, installation of services, other
construction, and for inspection. In excavating for footings and foundations, take
care not to disturb bottom of excavation. Excavate by hand to final grade just
before concrete reinforcement is placed. Trim bottoms to required lines and grades
to leave solid base to receive concrete.

This set of specifications requires judgment in application since some items are not
precisely specified. For example, excavation must extend a "sufficient" distance to
permit inspection and other activities. Obviously, the term "sufficient" in this case
may be subject to varying interpretations. In contrast, a specification that tolerances
are within plus or minus a tenth of a foot is subject to direct measurement.
However, specific requirements of the facility or characteristics of the site may
make the standard tolerance of a tenth of a foot inappropriate. Writing
specifications typically requires a trade-off between assuming reasonable behavior
on the part of all the parties concerned in interpreting words such as "sufficient"
versus the effort and possible inaccuracy in pre-specifying all operations.

In recent years, performance specifications have been developed for many

construction operations. Rather than specifying the required
construction process, these specifications refer to the required performance or
quality of the finished facility. The exact method by which this performance is
obtained is left to the construction contractor. For example, traditional
specifications for asphalt pavement specified the composition of the asphalt
material, the asphalt temperature during paving, and compacting procedures. In
contrast, a performance specification for asphalt would detail the desired
performance of the pavement with respect to impermeability, strength, etc. How the
desired performance level was attained would be up to the paving contractor. In
some cases, the payment for asphalt paving might increase with better quality of
asphalt beyond some minimum level of performance.

Example 13-1: Concrete Pavement Strength

Concrete pavements of superior strength result in cost savings by delaying the time
at which repairs or re-construction is required. In contrast, concrete of lower quality
will necessitate more frequent overlays or other repair procedures. Contract
provisions with adjustments to the amount of a contractor's compensation based on
pavement quality have become increasingly common in recognition of the cost
savings associated with higher quality construction. Even if a pavement does not
meet the "ultimate" design standard, it is still worth using the lower quality

452
pavement and re-surfacing later rather than completely rejecting the pavement.
Based on these life cycle cost considerations, a typical pay schedule might be: [1]
Load Ratio Pay Factor
<0.50 Reject
0.50-0.69 0.90
0.70-0.89 0.95
0.90-1.09 1.00
1.10-1.29 1.05
1.30-1.49 1.10
>1.50 1.12

In this table, the Load Ratio is the ratio of the actual pavement strength to the
desired design strength and the Pay Factor is a fraction by which the total pavement
contract amount is multiplied to obtain the appropriate compensation to the
contractor. For example, if a contractor achieves concrete strength twenty percent
greater than the design specification, then the load ratio is 1.20 and the appropriate
pay factor is 1.05, so the contractor receives a five percent bonus. Load factors are
computed after tests on the concrete actually used in a pavement. Note that a 90%
pay factor exists in this case with even pavement quality only 50% of that
originally desired. This high pay factor even with weak concrete strength might
exist since much of the cost of pavements are incurred in preparing the pavement
foundation. Concrete strengths of less then 50% are cause for complete rejection in
this case, however.

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13.4 Total Quality Control

Quality control in construction typically involves insuring compliance with
minimum standards of material and workmanship in order to insure the
performance of the facility according to the design. These minimum standards are
contained in the specifications described in the previous section. For the purpose of
insuring compliance, random samples and statistical methods are commonly used
as the basis for accepting or rejecting work completed and batches of materials.
Rejection of a batch is based on non-conformance or violation of the relevant
design specifications. Procedures for this quality control practice are described in
the following sections.

An implicit assumption in these traditional quality control practices is the notion of

an acceptable quality level which is a allowable fraction of defective items.
Materials obtained from suppliers or work performed by an organization is
inspected and passed as acceptable if the estimated defective percentage is within
the acceptable quality level. Problems with materials or goods are corrected after
delivery of the product.

453
In contrast to this traditional approach of quality control is the goal of total quality
control. In this system, no defective items are allowed anywhere in the construction
process. While the zero defects goal can never be permanently obtained, it provides
a goal so that an organization is never satisfied with its quality control program
even if defects are reduced by substantial amounts year after year. This concept and
approach to quality control was first developed in manufacturing firms in Japan and
Europe, but has since spread to many construction companies. The best known
formal certification for quality improvement is the International Organization for
Standardization's ISO 9000 standard. ISO 9000 emphasizes good documentation,
quality goals and a series of cycles of planning, implementation and review.

Total quality control is a commitment to quality expressed in all parts of an

organization and typically involves many elements. Design reviews to insure safe
and effective construction procedures are a major element. Other elements include
extensive training for personnel, shifting the responsibility for detecting defects
from quality control inspectors to workers, and continually maintaining equipment.
Worker involvement in improved quality control is often formalized in quality
circles in which groups of workers meet regularly to make suggestions for quality
improvement. Material suppliers are also required to insure zero defects in
delivered goods. Initally, all materials from a supplier are inspected and batches of
goods with any defective items are returned. Suppliers with good records can be
certified and not subject to complete inspection subsequently.

The traditional microeconomic view of quality control is that there is an "optimum"

proportion of defective items. Trying to achieve greater quality than this optimum
would substantially increase costs of inspection and reduce worker productivity.
However, many companies have found that commitment to total quality control has
substantial economic benefits that had been unappreciated in traditional
approaches. Expenses associated with inventory, rework, scrap and warranties were
reduced. Worker enthusiasm and commitment improved. Customers often
appreciated higher quality work and would pay a premium for good quality. As a
result, improved quality control became a competitive advantage.

Of course, total quality control is difficult to apply, particular in construction. The

unique nature of each facility, the variability in the workforce, the multitude of
subcontractors and the cost of making necessary investments in education and
procedures make programs of total quality control in construction difficult.
Nevertheless, a commitment to improved quality even without endorsing the goal
of zero defects can pay real dividends to organizations.

Example 13-2: Experience with Quality Circles

Quality circles represent a group of five to fifteen workers who meet on a frequent
basis to identify, discuss and solve productivity and quality problems. A circle
leader acts as liason between the workers in the group and upper levels of

454
management. Appearing below are some examples of reported quality circle
accomplishments in construction: [2]

1. On a highway project under construction by Taisei Corporation, it was found

that the loss rate of ready-mixed concrete was too high. A quality circle
composed of cement masons found out that the most important reason for
this was due to an inaccurate checking method. By applying the circle's
recommendations, the loss rate was reduced by 11.4%.
2. In a building project by Shimizu Construction Company, may cases of faulty
reinforced concrete work were reported. The iron workers quality circle
examined their work thoroughly and soon the faulty workmanship
disappeared. A 10% increase in productivity was also achieved.

Back to top

13.5 Quality Control by Statistical Methods

An ideal quality control program might test all materials and work on a particular
facility. For example, non-destructive techniques such as x-ray inspection of welds
can be used throughout a facility. An on-site inspector can witness the
appropriateness and adequacy of construction methods at all times. Even better,
individual craftsmen can perform continuing inspection of materials and their own
work. Exhaustive or 100% testing of all materials and work by inspectors can be
exceedingly expensive, however. In many instances, testing requires the destruction
of a material sample, so exhaustive testing is not even possible. As a result, small
samples are used to establish the basis of accepting or rejecting a particular work
item or shipment of materials. Statistical methods are used to interpret the results of
test on a small sample to reach a conclusion concerning the acceptability of an
entire lot or batch of materials or work products.

The use of statistics is essential in interpreting the results of testing on a small

sample. Without adequate interpretation, small sample testing results can be quite
misleading. As an example, suppose that there are ten defective pieces of material
in a lot of one hundred. In taking a sample of five pieces, the inspector might not
find any defective pieces or might have all sample pieces defective. Drawing a
direct inference that none or all pieces in the population are defective on the basis
of these samples would be incorrect. Due to this random nature of the sample
selection process, testing results can vary substantially. It is only with statistical
methods that issues such as the chance of different levels of defective items in the
full lot can be fully analyzed from a small sample test.

There are two types of statistical sampling which are commonly used for the
purpose of quality control in batches of work or materials:

455
 1. The acceptance or rejection of a lot is based on the number of defective (bad)
or nondefective (good) items in the sample. This is referred to as sampling
by attributes.
2. Instead of using defective and nondefective classifications for an item, a
quantitative quality measure or the value of a measured variable is used as a
quality indicator. This testing procedure is referred to as sampling by
variables.

Whatever sampling plan is used in testing, it is always assumed that the samples are
representative of the entire population under consideration. Samples are expected to
be chosen randomly so that each member of the population is equally likely to be
chosen. Convenient sampling plans such as sampling every twentieth piece,
choosing a sample every two hours, or picking the top piece on a delivery truck
may be adequate to insure a random sample if pieces are randomly mixed in a stack
or in use. However, some convenient sampling plans can be inappropriate. For
example, checking only easily accessible joints in a building component is
inappropriate since joints that are hard to reach may be more likely to have erection
or fabrication problems.

Another assumption implicit in statistical quality control procedures is that the

quality of materials or work is expected to vary from one piece to another. This is
certainly true in the field of construction. While a designer may assume that all
concrete is exactly the same in a building, the variations in material properties,
manufacturing, handling, pouring, and temperature during setting insure that
concrete is actually heterogeneous in quality. Reducing such variations to a
minimum is one aspect of quality construction. Insuring that the materials actually
placed achieve some minimum quality level with respect to average properties or
fraction of defectives is the task of quality control.

Back to top

13.6 Statistical Quality Control with Sampling by

Attributes
Sampling by attributes is a widely applied quality control method. The procedure is
intended to determine whether or not a particular group of materials or work
products is acceptable. In the literature of statistical quality control, a group of
materials or work items to be tested is called a lot or batch. An assumption in the
procedure is that each item in a batch can be tested and classified as either
acceptable or deficient based upon mutually acceptable testing procedures and
acceptance criteria. Each lot is tested to determine if it satisfies a minimum
acceptable quality level (AQL) expressed as the maximum percentage of defective
items in a lot or process.

456
In its basic form, sampling by attributes is applied by testing a pre-defined number
of sample items from a lot. If the number of defective items is greater than a trigger
level, then the lot is rejected as being likely to be of unacceptable quality.
Otherwise, the lot is accepted. Developing this type of sampling plan requires
consideration of probability, statistics and acceptable risk levels on the part of the
supplier and consumer of the lot. Refinements to this basic application procedure
are also possible. For example, if the number of defectives is greater than some pre-
defined number, then additional sampling may be started rather than immediate
rejection of the lot. In many cases, the trigger level is a single defective item in the
sample. In the remainder of this section, the mathematical basis for interpreting this
type of sampling plan is developed.

More formally, a lot is defined as acceptable if it contains a fraction p1 or less

defective items. Similarly, a lot is defined as unacceptable if it contains a fraction
p2 or more defective units. Generally, the acceptance fraction is less than or equal
to the rejection fraction, p1 p2, and the two fractions are often equal so that there
is no ambiguous range of lot acceptability between p1 and p2. Given a sample size
and a trigger level for lot rejection or acceptance, we would like to determine the
probabilities that acceptable lots might be incorrectly rejected (termed producer's
risk) or that deficient lots might be incorrectly accepted (termed consumer's risk).

Consider a lot of finite number N, in which m items are defective (bad) and the
remaining (N-m) items are non-defective (good). If a random sample of n items is
taken from this lot, then we can determine the probability of having different
numbers of defective items in the sample. With a pre-defined acceptable number of
defective items, we can then develop the probability of accepting a lot as a function
of the sample size, the allowable number of defective items, and the actual fraction
of defective items. This derivation appears below.

The number of different samples of size n that can be selected from a finite
population N is termed a mathematical combination and is computed as:

(13.1)

where a factorial, n! is n*(n-1)*(n-2)...(1) and zero factorial (0!) is one by

convention. The number of possible samples with exactly x defectives is the
combination associated with obtaining x defectives from m possible defective items
and n-x good items from N-m good items:

457
(13.2)

Given these possible numbers of samples, the probability of having exactly x

defective items in the sample is given by the ratio as the hypergeometric series:

(13.3)

With this function, we can calculate the probability of obtaining different numbers
of defectives in a sample of a given size.

Suppose that the actual fraction of defectives in the lot is p and the actual fraction
of nondefectives is q, then p plus q is one, resulting in m = Np, and N - m = Nq.
Then, a function g(p) representing the probability of having r or less defective items
in a sample of size n is obtained by substituting m and N into Eq. (13.3) and
summing over the acceptable defective number of items:

(13.4)

If the number of items in the lot, N, is large in comparison with the sample size n,
then the function g(p) can be approximated by the binomial distribution:

(13.5)

or

(13.6)

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The function g(p) indicates the probability of accepting a lot, given the sample size
n and the number of allowable defective items in the sample r. The function g(p)
can be represented graphical for each combination of sample size n and number of
allowable defective items r, as shown in Figure 13-1. Each curve is referred to as
the operating characteristic curve (OC curve) in this graph. For the special case of a
single sample (n=1), the function g(p) can be simplified:

(13.7)

so that the probability of accepting a lot is equal to the fraction of acceptable items
in the lot. For example, there is a probability of 0.5 that the lot may be accepted
from a single sample test even if fifty percent of the lot is defective.

Figure 13-1 Example Operating Characteristic Curves Indicating Probability of

Lot Acceptance

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For any combination of n and r, we can read off the value of g(p) for a given p from
the corresponding OC curve. For example, n = 15 is specified in Figure 13-1. Then,
for various values of r, we find:

r=0 p=24% g(p) 2%

r=0 p=4% g(p) 54%
r=1 p=24% g(p) 10%
r=1 p=4% g(p) 88%

The producer's and consumer's risk can be related to various points on an operating
characteristic curve. Producer's risk is the chance that otherwise acceptable lots fail
the sampling plan (ie. have more than the allowable number of defective items in
the sample) solely due to random fluctuations in the selection of the sample. In
contrast, consumer's risk is the chance that an unacceptable lot is acceptable (ie. has
less than the allowable number of defective items in the sample) due to a better
than average quality in the sample. For example, suppose that a sample size of 15 is
chosen with a trigger level for rejection of one item. With a four percent acceptable
level and a greater than four percent defective fraction, the consumer's risk is at
most eighty-eight percent. In contrast, with a four percent acceptable level and a
four percent defective fraction, the producer's risk is at most 1 - 0.88 = 0.12 or
twelve percent.

In specifying the sampling plan implicit in the operating characteristic curve, the
supplier and consumer of materials or work must agree on the levels of risk
acceptable to themselves. If the lot is of acceptable quality, the supplier would like
to minimize the chance or risk that a lot is rejected solely on the basis of a lower
than average quality sample. Similarly, the consumer would like to minimize the
risk of accepting under the sampling plan a deficient lot. In addition, both parties
presumably would like to minimize the costs and delays associated with testing.
Devising an acceptable sampling plan requires trade off the objectives of risk
minimization among the parties involved and the cost of testing.

Example 13-3: Acceptance probability calculation

Suppose that the sample size is five (n=5) from a lot of one hundred items (N=100).
The lot of materials is to be rejected if any of the five samples is defective (r = 0).
In this case, the probability of acceptance as a function of the actual number of
defective items can be computed by noting that for r = 0, only one term (x = 0)
need be considered in Eq. (13.4). Thus, for N = 100 and n = 5:

460
For a two percent defective fraction (p = 0.02), the resulting acceptance value is:

Using the binomial approximation in Eq. (13.5), the comparable calculation would
be:

which is a difference of 0.0019, or 0.21 percent from the actual value of 0.9020
found above.

If the acceptable defective proportion was two percent (so p1 = p2 = 0.02), then the
chance of an incorrect rejection (or producer's risk) is 1 - g(0.02) = 1 - 0.9 = 0.1 or
ten percent. Note that a prudent producer should insure better than minimum
quality products to reduce the probability or chance of rejection under this
sampling plan. If the actual proportion of defectives was one percent, then the
producer's risk would be only five percent with this sampling plan.

Example 13-4: Designing a Sampling Plan

Suppose that an owner (or product "consumer" in the terminology of quality

control) wishes to have zero defective items in a facility with 5,000 items of a
particular kind. What would be the different amounts of consumer's risk for
different sampling plans?

With an acceptable quality level of no defective items (so p1 = 0), the allowable
defective items in the sample is zero (so r = 0) in the sampling plan. Using the
binomial approximation, the probability of accepting the 5,000 items as a function
of the fraction of actual defective items and the sample size is:

To insure a ninety percent chance of rejecting a lot with an actual percentage

defective of one percent (p = 0.01), the required sample size would be calculated
as:

461
Then,

As can be seen, large sample sizes are required to insure relatively large
probabilities of zero defective items.

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13.7 Statistical Quality Control with Sampling by

Variables
As described in the previous section, sampling by attributes is based on a
classification of items as good or defective. Many work and material attributes
possess continuous properties, such as strength, density or length. With the
sampling by attributes procedure, a particular level of a variable quantity must be
defined as acceptable quality. More generally, two items classified as good might
have quite different strengths or other attributes. Intuitively, it seems reasonable
that some "credit" should be provided for exceptionally good items in a sample.
Sampling by variables was developed for application to continuously measurable
quantities of this type. The procedure uses measured values of an attribute in a
sample to determine the overall acceptability of a batch or lot. Sampling by
variables has the advantage of using more information from tests since it is based
on actual measured values rather than a simple classification. As a result,
acceptance sampling by variables can be more efficient than sampling by attributes
in the sense that fewer samples are required to obtain a desired level of quality
control.

In applying sampling by variables, an acceptable lot quality can be defined with

respect to an upper limit U, a lower limit L, or both. With these boundary
conditions, an acceptable quality level can be defined as a maximum allowable
fraction of defective items, M. In Figure 13-2, the probability distribution of item
attribute x is illustrated. With an upper limit U, the fraction of defective items is
equal to the area under the distribution function to the right of U (so that x U).
This fraction of defective items would be compared to the allowable fraction M to
determine the acceptability of a lot. With both a lower and an upper limit on
acceptable quality, the fraction defective would be the fraction of items greater than
the upper limit or less than the lower limit. Alternatively, the limits could be
imposed upon the acceptable average level of the variable

462
Figure 13-2 Variable Probability Distributions and Acceptance Regions

In sampling by variables, the fraction of defective items is estimated by using

measured values from a sample of items. As with sampling by attributes, the
procedure assumes a random sample of a give size is obtained from a lot or batch.
In the application of sampling by variables plans, the measured characteristic is
virtually always assumed to be normally distributed as illustrated in Figure 13-2.
The normal distribution is likely to be a reasonably good assumption for many
measured characteristics such as material density or degree of soil compaction. The
Central Limit Theorem provides a general support for the assumption: if the source
of variations is a large number of small and independent random effects, then the
resulting distribution of values will approximate the normal distribution. If the
distribution of measured values is not likely to be approximately normal, then
sampling by attributes should be adopted. Deviations from normal distributions
may appear as skewed or non-symmetric distributions, or as distributions with fixed
upper and lower limits.

The fraction of defective items in a sample or the chance that the population
average has different values is estimated from two statistics obtained from the
sample: the sample mean and standard deviation. Mathematically, let n be the
number of items in the sample and xi, i = 1,2,3,...,n, be the measured values of the

463
variable characteristic x. Then an estimate of the overall population mean is the
sample mean :

(13.8)

An estimate of the population standard deviation is s, the square root of the sample
variance statistic:

(13.9)

Based on these two estimated parameters and the desired limits, the various
fractions of interest for the population can be calculated.

The probability that the average value of a population is greater than a particular
lower limit is calculated from the test statistic:

(13.10)

which is t-distributed with n-1 degrees of freedom. If the population standard

deviation is known in advance, then this known value is substituted for the
estimate s and the resulting test statistic would be normally distributed. The t
distribution is similar in appearance to a standard normal distribution, although the
spread or variability in the function decreases as the degrees of freedom
parameter increases. As the number of degrees of freedom becomes very large, the
t-distribution coincides with the normal distribution.

With an upper limit, the calculations are similar, and the probability that the
average value of a population is less than a particular upper limit can be calculated
from the test statistic:

(13.11)

464
With both upper and lower limits, the sum of the probabilities of being above the
upper limit or below the lower limit can be calculated.

The calculations to estimate the fraction of items above an upper limit or below a
lower limit are very similar to those for the population average. The only difference
is that the square root of the number of samples does not appear in the test statistic
formulas:

(13.12)

and

(13.13)

where tAL is the test statistic for all items with a lower limit and tAU is the test
statistic for all items with a upper limit. For example, the test statistic for items
above an upper limit of 5.5 with = 4.0, s = 3.0, and n = 5 is tAU = (8.5 - 4.0)/3.0 =
1.5 with n - 1 = 4 degrees of freedom.

Instead of using sampling plans that specify an allowable fraction of defective

items, it saves computations to simply write specifications in terms of the allowable
test statistic values themselves. This procedure is equivalent to requiring that the
sample average be at least a pre-specified number of standard deviations away from
an upper or lower limit. For example, with = 4.0, U = 8.5, s = 3.0 and n = 41, the
sample mean is only about (8.5 - 4.0)/3.0 = 1.5 standard deviations away from the
upper limit.

To summarize, the application of sampling by variables requires the specification

of a sample size, the relevant upper or limits, and either (1) the allowable fraction
of items falling outside the designated limits or (2) the allowable probability that
the population average falls outside the designated limit. Random samples are
drawn from a pre-defined population and tested to obtained measured values of a
variable attribute. From these measurements, the sample mean, standard deviation,
and quality control test statistic are calculated. Finally, the test statistic is compared
to the allowable trigger level and the lot is either accepted or rejected. It is also
possible to apply sequential sampling in this procedure, so that a batch may be
subjected to additional sampling and testing to further refine the test statistic
values.

465
With sampling by variables, it is notable that a producer of material or work can
adopt two general strategies for meeting the required specifications. First, a
producer may insure that the average quality level is quite high, even if the
variability among items is high. This strategy is illustrated in Figure 13-3 as a "high
quality average" strategy. Second, a producer may meet a desired quality target by
reducing the variability within each batch. In Figure 13-3, this is labeled the "low
variability" strategy. In either case, a producer should maintain high standards to
avoid rejection of a batch.

Figure 13-3 Testing for Defective Component Strengths

Example 13-5: Testing for defective component strengths

Suppose that an inspector takes eight strength measurements with the following
results:

4.3, 4.8, 4.6, 4.7, 4.4, 4.6, 4.7, 4.6

In this case, the sample mean and standard deviation can be calculated using
Equations (13.8) and (13.9):

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 = 1/8(4.3 + 4.8 + 4.6 + 4.7 + 4.4 + 4.6 + 4.7 + 4.6) = 4.59
s =[1/(8-1)][(4.3 - 4.59)2 + (4.8 - 4.59)2 + (4.6 - 4.59)2 + (4.7 - 4.59)2 + (4.4 -
2

4.59)2 + (4.6 - 4.59)2 + (4.7 - 4.59)2 + (4.6 - 4.59)2] = 0.16

The percentage of items below a lower quality limit of L = 4.3 is estimated from
the test statistic tAL in Equation (13.12):

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13.8 Safety
Construction is a relatively hazardous undertaking. As Table 13-1 illustrates, there
are significantly more injuries and lost workdays due to injuries or illnesses in
construction than in virtually any other industry. These work related injuries and
illnesses are exceedingly costly. The Construction Industry Cost Effectiveness
Project estimated that accidents cost $8.9 billion or nearly seven percent of the
$137 billion (in 1979 dollars) spent annually for industrial, utility and commercial
construction in the United States. [3] Included in this total are direct costs (medical
costs, premiums for workers' compensation benefits, liability and property losses)
as well as indirect costs (reduced worker productivity, delays in projects,
administrative time, and damage to equipment and the facility). In contrast to most
industrial accidents, innocent bystanders may also be injuried by construction
accidents. Several crane collapses from high rise buildings under construction have
resulted in fatalities to passerbys. Prudent project managers and owners would like
to reduce accidents, injuries and illnesses as much as possible.

TABLE 13-1 Nonfatal Occupational Injury and Illness Incidence Rates

Industry
Agriculture, forestry, fishing 8.7 6
Mining 5.4 3.5
Construction 9.9 5.9
Manufacturing 10.6 6
Trade,Transportation and utilities 8.7 5
Financial activities 2.4 1.5
Professional and business services19962006 6.0 1.2

Note: Data represent total number of cases per 100 full-time employees
Source: U.S. Bureau of Labor Statistics, Occupational injuries and Illnesses in the United
States by Industry, annual

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As with all the other costs of construction, it is a mistake for owners to ignore a
significant category of costs such as injury and illnesses. While contractors may
pay insurance premiums directly, these costs are reflected in bid prices or contract
amounts. Delays caused by injuries and illnesses can present significant
opportunity costs to owners. In the long run, the owners of constructed facilities
must pay all the costs of construction. For the case of injuries and illnesses, this
general principle might be slightly qualified since significant costs are borne by
workers themselves or society at large. However, court judgements and insurance
payments compensate for individual losses and are ultimately borne by the owners.

The causes of injuries in construction are numerous. Table 13-2 lists the reported
causes of accidents in the US construction industry in 1997 and 2004. A similar
catalogue of causes would exist for other countries. The largest single category for
both injuries and fatalities are individual falls. Handling goods and transportation
are also a significant cause of injuries. From a management perspective, however,
these reported causes do not really provide a useful prescription for safety policies.
An individual fall may be caused by a series of coincidences: a railing might not be
secure, a worker might be inattentive, the footing may be slippery, etc. Removing
any one of these compound causes might serve to prevent any particular accident.
However, it is clear that conditions such as unsecured railings will normally
increase the risk of accidents. Table 13-3 provides a more detailed list of causes of
fatalities for construction sites alone, but again each fatality may have multiple
causes.

TABLE 13-2 Fatal Occupational Injuries in

Construction, 1997 and 2004
Year 1997 2004
Total fatalities
Falls 1,107 1,234
Transportation incidents 376 445
Contact with objects & 288 287
equipment 199 267
Exposure to harmful substances 188 170
and environments
Source: Bureau of Labor Statistics

TABLE 13-3 Fatality Causes in Construction, 1996/1997 and 2006/2007

Year
Total accidents 287 241
Falls from a height 88 45
Struck by a moving vehicle 43 30
Struck by moving/falling object 57 40
Trapped by something overturning/collapsing 16 19
Drowning/asphyxiation96/9706/07 9 16

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 Source: Bureau of Labor Statistics

Various measures are available to improve jobsite safety in construction. Several of

the most important occur before construction is undertaken. These include design,
choice of technology and education. By altering facility designs, particular
structures can be safer or more hazardous to construct. For example, parapets can
be designed to appropriate heights for construction worker safety, rather than the
minimum height required by building codes.

Choice of technology can also be critical in determining the safety of a jobsite.

Safeguards built into machinery can notify operators of problems or prevent
injuries. For example, simple switches can prevent equipment from being operating
when protective shields are not in place. With the availability of on-board
electronics (including computer chips) and sensors, the possibilities for
sophisticated machine controllers and monitors has greatly expanded for
construction equipment and tools. Materials and work process choices also
influence the safety of construction. For example, substitution of alternative
materials for asbestos can reduce or eliminate the prospects of long term illnesses
such as asbestiosis.

Educating workers and managers in proper procedures and hazards can have a
direct impact on jobsite safety. The realization of the large costs involved in
construction injuries and illnesses provides a considerable motivation for awareness
and education. Regular safety inspections and safety meetings have become
standard practices on most job sites.

Pre-qualification of contractors and sub-contractors with regard to safety is another

important avenue for safety improvement. If contractors are only invitied to bid or
enter negotiations if they have an acceptable record of safety (as well as quality
performance), then a direct incentive is provided to insure adequate safety on the
part of contractors.

During the construction process itself, the most important safety related measures
are to insure vigilance and cooperation on the part of managers, inspectors and
workers. Vigilance involves considering the risks of different working practices. In
also involves maintaining temporary physical safeguards such as barricades, braces,
guylines, railings, toeboards and the like. Sets of standard practices are also
important, such as: [4]

• requiring hard hats on site.

• requiring eye protection on site.
• requiring hearing protection near loud equipment.
• insuring safety shoes for workers.

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 • providing first-aid supplies and trained personnel on site

While eliminating accidents and work related illnesses is a worthwhile goal, it will
never be attained. Construction has a number of characteristics making it inherently
hazardous. Large forces are involved in many operations. The jobsite is continually
changing as construction proceeds. Workers do not have fixed worksites and must
move around a structure under construction. The tenure of a worker on a site is
short, so the worker's familiarity and the employer-employee relationship are less
settled than in manufacturing settings. Despite these peculiarities and as a result of
exactly these special problems, improving worksite safety is a very important
project management concern.

Example 13-6: Trench collapse [5]

To replace 1,200 feet of a sewer line, a trench of between 12.5 and 18 feet deep was
required down the center of a four lane street. The contractor chose to begin
excavation of the trench from the shallower end, requiring a 12.5 deep trench.
Initially, the contractor used a nine foot high, four foot wide steel trench box for
soil support. A trench box is a rigid steel frame consisting of two walls supported
by welded struts with open sides and ends. This method had the advantage that
traffic could be maintained in at least two lanes during the reconstruction work.

In the shallow parts of the trench, the trench box seemed to adequately support the
excavation. However, as the trench got deeper, more soil was unsupported below
the trench box. Intermittent soil collapses in the trench began to occur. Eventually,
an old parallel six inch water main collapsed, thereby saturating the soil and
leading to massive soil collapse at the bottom of the trench. Replacement of the
water main was added to the initial contract. At this point, the contractor began
sloping the sides of the trench, thereby requiring the closure of the entire street.

The initial use of the trench box was convenient, but it was clearly inadequate and
unsafe. Workers in the trench were in continuing danger of accidents stemming
from soil collapse. Disruption to surrounding facilities such as the parallel water
main was highly likely. Adoption of a tongue and groove vertical sheeting system
over the full height of the trench or, alternatively, the sloping excavation eventually
adopted are clearly preferable.

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13.9 References
1. Ang, A.H.S. and W.H. Tang, Probability Concepts in Engineering Planning
and Design: Volume I - Basic Principles, John Wiley and Sons, Inc., New
York, 1975.

470
 2. Au, T., R.M. Shane, and L.A. Hoel, Fundamentals of Systems Engineering:
Probabilistic Models, Addison-Wesley Publishing Co., Reading MA, 1972
3. Bowker, A.H. and Liebermann, G. J., Engineering Statistics, Prentice-Hall,
1972.
4. Fox, A.J. and Cornell, H.A., (eds), Quality in the Constructed
Project, American Society of Civil Engineers, New York, 1984.
5. International Organization for Standardization, "Sampling Procedures and
Charts for Inspection by Variables for Percent Defective, ISO 3951-1981
(E)", Statistical Methods, ISO Standard Handbook 3, International
Organization for Standardization, Paris, France, 1981.
6. Skibniewski, M. and Hendrickson, C., Methods to Improve the Safety
Performance of the U.S. Construction Industry, Technical Report,
Department of Civil Engineering, Carnegie Mellon University, 1983.
7. United States Department of Defense, Sampling Procedures and Tables for
Inspection by Variables, (Military Standard 414), Washington D.C.: U.S.
Government Printing Office, 1957.
8. United States Department of Defense, Sampling Procedures and Tables for
Inspection by Attributes, (Military Standard 105D), Washington D.C.: U.S.
Government Printing Office, 1963.

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13.10 Problems
1. Consider the following specification. Would you consider it to be a process
or performance specification? Why?

"Water used in mixing or curing shall be reasonably clean and free of oil,
salt, acid, alkali, sugar, vegetable, or other substance injurious to the finished
product...Water known to be potable quality may be used without test.
Where the source of water is relatively shallow, the intake shall be so
enclosed as to exclude silt, mud, grass, or other foreign materials." [6]

2. Suppose that a sampling plan calls for a sample of size n = 50. To be

acceptable, only three or fewer samples can be defective. Estimate the
probability of accepting the lot if the average defective percentage is (a)
15%, (b) 5% or (c) 2%. Do not use an approximation in this calculation.

3. Repeat Problem 2 using the binomial approximation.

4. Suppose that a project manager tested the strength of one tile out of a batch
of 3,000 to be used on a building. This one sample measurement was
compared with the design specification and, in this case, the sampled tile's
strength exceeded that of the specification. On this basis, the project
manager accepted the tile shipment. If the sampled tile was defective (with a

471
 strength less than the specification), the project manager would have rejected
the lot.

a. What is the probability that ninety percent of the tiles are substandard,
even though the project manager's sample gave a satisfactory result?
b. Sketch out the operating characteristic curve for this sampling plan as a
function of the actual fraction of defective tiles.

5. Repeat Problem 4 for sample sizes of (a) 5, (b) 10 and (c) 20.

6. Suppose that a sampling-by-attributes plan is specified in which ten samples

are taken at random from a large lot (N=100) and at most one sample item is
allowed to be defective for the lot to be acceptable.

a. If the actual percentage defective is five percent, what is the probability of

lot acceptance? (Note: you may use relevant approximations in this
calculation.)
b. What is the consumer's risk if an acceptable quality level is fifteen percent
defective and the actual fraction defective is five percent?
c. What is the producer's risk with this sampling plan and an eight percent
defective percentage?

7. The yield stress of a random sample of 25 pieces of steel was measured,

yielding a mean of 52,800 psi. and an estimated standard deviation of s =
4,600 psi.

a. What is the probability that the population mean is less than 50,000 psi?
b. What is the estimated fraction of pieces with yield strength less than
50,000 psi?
c. Is this sampling procedure sampling-by-attributes or sampling-by-
variable?

8. Suppose that a contract specifies a sampling-by-attributes plan in which ten

samples are taken at random from a large lot (N=100) and at most one
sample is allowed to be defective for the lot to be acceptable.

a. If the actual percentage defective is five percent, what is the probability of

lot acceptance? (Note: you may use relevant approximations in this
calculation).
b. What is the consumer's risk if an acceptable quality level is fifteen percent
defective and the actual fraction defective is 0.05?
c. What is the producer's risk with this sampling plan and a 8% defective
percentage?

472
 9. In a random sample of 40 blocks chosen from a production line, the mean
length was 10.63 inches and the estimated standard deviation was 0.4 inch.
Between what lengths can it be said that 98% of block lengths will lie?

Back to top

13.11 Footnotes
1. This illustrative pay factor schedule is adapted from R.M. Weed, "Development
of Multicharacteristic Acceptance Procedures for Rigid Pavement," Transportation
Research Record 885, 1982, pp. 25-36. Back

2. B.A. Gilly, A. Touran, and T. Asai, "Quality Control Circles in

Construction," ASCE Journal of Construction Engineering and Management, Vol.
113, No. 3, 1987, pg 432. Back

3. See Improving Construction Safety Performance, Report A-3, The Business

Roundtable, New York, NY, January 1982. Back

4. Hinze, Jimmie W., Construction Safety,, Prentice-Hall, 1997. Back

5. This example was adapted from E. Elinski, External Impacts of Reconstruction

and Rehabilitation Projects with Implications for Project
Management, Unpublished MS Thesis, Department of Civil Engineering, Carnegie
Mellon University, 1985. Back

6. American Association of State Highway and Transportation Officials, Guide

Specifications for Highway Construction, Washington, D.C., Section 714.01, pg.
244. Back

473
14. Organization and Use of Project
Information
14.1 Types of Project Information
Construction projects inevitably generate enormous and complex sets of
information. Effectively managing this bulk of information to insure its availability
and accuracy is an important managerial task. Poor or missing information can
readily lead to project delays, uneconomical decisions, or even the complete failure
of the desired facility. Pity the owner and project manager who suddenly discover
on the expected delivery date that important facility components have not yet been
fabricated and cannot be delivered for six months! With better information, the
problem could have been identified earlier, so that alternative suppliers might have
been located or schedules arranged. Both project design and control are crucially
dependent upon accurate and timely information, as well as the ability to use this
information effectively. At the same time, too much unorganized information
presented to managers can result in confusion and paralysis of decision making.

As a project proceeds, the types and extent of the information used by the various
organizations involved will change. A listing of the most important information
sets would include:

• cash flow and procurement accounts for each organization,

• intermediate analysis results during planning and design,
• design documents, including drawings and specifications,
• construction schedules and cost estimates,
• quality control and assurance records,
• chronological files of project correspondence and memorandum,
• construction field activity and inspection logs,
• legal contracts and regulatory documents.

Some of these sets of information evolve as the project proceeds. The financial
accounts of payments over the entire course of the project is an example of overall
growth. The passage of time results in steady additions in these accounts, whereas
the addition of a new actor such as a contractor leads to a sudden jump in the
number of accounts. Some information sets are important at one stage of the
process but may then be ignored. Common examples include planning or structural
analysis databases which are not ordinarily used during construction or operation.
However, it may be necessary at later stages in the project to re-do analyses to
consider desired changes. In this case, archival information storage and retrieval
become important. Even after the completion of construction, an historical record

474
may be important for use during operation, to assess responsibilities in case of
facility failures or for planning similar projects elsewhere.

The control and flow of information is also important for collaborative work
environments, where many professionals are working on different aspects of a
project and sharing information. Collaborative work environments provide facilities
for sharing datafiles, tracing decisions, and communication via electronic mail or
video conferencing. The datastores in these collaborative work environments may
become very large.

Based on several construction projects, Maged Abdelsayed of Tardif, Murray &

Assoc (Quebec, Canada) estimated the following average figures for a typical
project of US$10 million:

• Number of participants (companies): 420 (including all suppliers and sub-

sub-contractors)
• Number of participants (individuals): 850
• Number of different types of documents generated: 50
• Number of pages of documents: 56,000
• Number of bankers boxes to hold project documents: 25
• Number of 4 drawers filing cabinets: 6
• Number of 20inch diameter, 20 year old, 50 feet high, trees used to generate
this volume of paper: 6
• Equivalent number of Mega Bytes of electronic data to hold this volume of
paper (scanned): 3,000 MB
• Equivalent number of compact discs (CDs): 6

While there may be substantial costs due to inaccurate or missing information,

there are also significant costs associated with the generation, storage, transfer,
retrieval and other manipulation of information. In addition to the costs of clerical
work and providing aids such as computers, the organization and review of
information command an inordinate amount of the attention of project managers,
which may be the scarcest resource on any construction project. It is useful,
therefore, to understand the scope and alternatives for organizing project
information.

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14.2 Accuracy and Use of Information

Numerous sources of error are expected for project information. While numerical
values are often reported to the nearest cent or values of equivalent precision, it is
rare that the actual values are so accurately known. Living with some uncertainty is
an inescapable situation, and a prudent manager should have an understanding of

475
the uncertainty in different types of information and the possibility of drawing
misleading conclusions.

We have already discussed the uncertainty inherent in making forecasts of project

costs and durations sometime in the future. Forecast uncertainty also exists in the
short term. For example, consider estimates of work completed. Every project
manager is familiar with situations in which the final few bits of work for a task
take an inordinate amount of time. Unforeseen problems, inadequate quality on
already completed work, lack of attention, accidents, or postponing the most
difficult work problems to the end can all contribute to making the final portion of
an activity actually require far more time and effort than expected. The net result is
that estimates of the actual proportion of work completed are often inaccurate.

Some inaccuracy in reports and estimates can arise from conscious choices made
by workers, foremen or managers. If the value of insuring accuracy is thought to be
low or nonexistent, then a rational worker will not expend effort or time to gather
or to report information accurately. Many project scheduling systems flounder on
exactly this type of non-reporting or mis-reporting. The original schedule can
quickly become extremely misleading without accurate updating! Only if all parties
concerned have specific mandates or incentives to report accurately will the data be
reliable.

Another source of inaccuracy comes from transcription errors of various sorts.

Typographical errors, incorrect measurements from reading equipment, or other
recording and calculation errors may creep into the sets of information which are
used in project management. Despite intensive efforts to check and eliminate such
errors, their complete eradication is virtually impossible.

One method of indicating the relative accuracy of numerical data is to report ranges
or expected deviations of an estimate or measurement. For example, a measurement
might be reported as 198 ft. + 2 ft. There are two common interpretations of these
deviations. First, a range (such as + 2) might be chosen so that the actual value
is certain to be within the indicated range. In the case above, the actual length
would be somewhere between 196 and 200 feet with this convention. Alternatively,
this deviation might indicate the typical range of the estimate or measurement. In
this case, the example above might imply that there is, say, a two-thirds chance that
the actual length is between 196 and 200.

When the absolute range of a quantity is very large or unknown, the use of a
statistical standard deviation as a measure of uncertainty may be useful. If a
quantity is measured n times resulting is a set of values xi (i = 1,2,...,n), then the
average or mean value then the average or mean value is given by:

476
(14.1)

The standard deviation can be estimated as the square root s of the sample
variance s2, i.e. , where:

(14.2)

The standard deviation is a direct indicator of the spread or variability in a

measurement, in the same units as the measurement itself. Higher values of the
standard deviation indicate greater and greater uncertainty about the exact value of
the measurement. For the commonly encountered normal distribution of a random
variable, the average value plus or minus one standard deviation, + , will
include about two-thirds ofx the actual occurrences. A related measure of random
variability is the coefficient of variation, defined as the ratio of the standard
deviation to the mean:

(14.3)

Thus, a coefficient of variation indicates the variability as a proportion of the

expected value. A coefficient of variation equal to one (c = 1) represents substantial
uncertainty, whereas a value such as c = 0.1 or ten percent indicates much smaller
variability.

More generally, even information which is gathered and reported correctly may be
interpreted incorrectly. While the actual information might be correct within the
terms of the data gathering and recording system, it may be quite misleading for
managerial purposes. A few examples can illustrate the problems which may arise
in naively interpreting recorded information without involving any conceptual
understanding of how the information is actually gathered, stored and recorded or
how work on the project actually proceeds.

Example 14-1: Sources of Delay and Cost Accounts

It is common in construction activity information to make detailed records of costs

incurred and work progress. It is less common to keep detailed records of delays
and their causes, even though these delays may be the actual cause of increased
costs and lower productivity. [1] Paying exclusive attention to cost accounts in such
situations may be misleading. For example, suppose that the accounts for

477
equipment and material inventories show cost savings relative to original estimates,
whereas the costs associated with particular construction activities show higher
than estimated expenditures. In this situation, it is not necessarily the case that the
inventory function is performing well, whereas the field workers are the cause of
cost overrun problems. It may be that construction activities are delayed by lack of
equipment or materials, thus causing cost increases. Keeping a larger inventory of
materials and equipment might increase the inventory account totals, but lead to
lower overall costs on the project. Better yet, more closely matching demands and
supplies might reduce delay costs without concurrent inventory cost increases.
Thus, simply examining cost account information may not lead to a correct
diagnosis of a problem or to the correct managerial responses.

Example 14-2: Interest Charges

Financial or interest charges are usually accumulated in a separate account for

projects, while the accounts associated with particular activities represent actual
expenditures. For example, planning activities might cost $10,000 for a small
project during the first year of a two year project. Since dollar expenditures have a
time value, this $10,000 cost in year 1 is not equivalent in value to a $10,000 cost
in year 2. In particular, financing the early $10,000 involves payment of interest or,
similarly, the loss of investment opportunities. If the borrowing rate was 10%, then
financing the first year $10,000 expenditure would require $10,000 x 0.10 = $1,000
and the value of the expenditure by the end of the second year of the project would
be $11,000. Thus, some portion of the overall interest charges represents a cost
associated with planning activities. Recognizing the true value of expenditures
made at different periods of time is an important element in devising rational
planning and management strategies.
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14.3 Computerized Organization and Use of Information

Numerous formal methods and possible organizations exist for the information
required for project management. Before discussing the details of computations and
information representation, it will be useful to describe a record keeping
implementation, including some of the practical concerns in design and
implementation. In this section, we shall describe a computer based system to
provide construction yard and warehouse management information from the point
of view of the system users. [2] In the process, the usefulness of computerized
databases can be illustrated.

A yard or warehouse is used by most construction firms to store equipment and to

provide an inventory of materials and parts needed for projects. Large firms may
have several warehouses at different locations so as to reduce transit time between
project sites and materials supplies. In addition, local "yards" or "equipment sheds"
are commonly provided on the job site. Examples of equipment in a yard would be

478
drills, saws, office trailers, graders, back hoes, concrete pumps and cranes. Material
items might include nails, plywood, wire mesh, forming lumber, etc.

In typical construction warehouses, written records are kept by warehouse clerks to

record transfer or return of equipment to job sites, dispatch of material to jobs, and
maintenance histories of particular pieces of equipment. In turn, these records are
used as the basis for billing projects for the use of equipment and materials. For
example, a daily charge would be made to a project for using a concrete pump.
During the course of a month, the concrete pump might spend several days at
different job sites, so each project would be charged for its use. The record keeping
system is also used to monitor materials and equipment movements between sites
so that equipment can be located.

One common mechanism to organize record keeping is to fill out cards recording
the transfer of items to or from a job site. Table 14-1 illustrates one possible
transfer record. In this case, seven items were requested for the Carnegie-Mellon
job site (project number 83-1557). These seven items would be loaded on a
delivery truck, along with a copy of the transfer record. Shown in Table 14-1 is a
code number identifying each item (0609.02, 0609.03, etc.), the quantity of each
item requested, an item description and a unit price. For equipment items, an
equipment number identifying the individual piece of equipment used is also
recorded, such as grinder No. 4517 in Table 14-1; a unit price is not specified for
equipment but a daily rental charge might be imposed.

TABLE 14-1 Illustration of a Construction Warehouse Transfer Record

TRANSFER SHEET NUMBER 100311
Deliver To: Carnegie-Mellon Job. No. 83-1557
Received From: Pittsburgh Warehouse Job No. 99-PITT
ITEM NO. EQ. NO. QTY DESCRIPTION UNIT PRICE
0609.02 200 Hilti Pins NK27 $0.36
0609.03 200 Hilti Pins NK27 0.36
0188.21 1 Kiel, Box of 12 6.53
0996.01 3 Paint, Spray 5.57
0607.03 4 Plywood, 4 x 8 x 1/4" 11.62
0172.00 4517 1 Grinder
0181.53 1 Grinding Wheel, 6" Cup 14.97
Preparer: Vicki Date: x/xx/xx

Transfer sheets are numbered (such as No. 100311 in Table 14-1), dated and the
preparer identified to facilitate control of the record keeping process. During the
course of a month, numerous transfer records of this type are accumulated. At the
end of a month, each of the transfer records is examined to compile the various
items or equipment used at a project and the appropriate charges. Constructing
these bills would be a tedious manual task. Equipment movements would have to

479
be tracked individually, days at each site counted, and the daily charge accumulated
for each project. For example, Table 14-1 records the transfer of grinder No. 4517
to a job site. This project would be charged a daily rental rate until the grinder was
returned. Hundreds or thousands of individual item transfers would have to be
examined, and the process of preparing bills could easily require a week or two of
effort.

In addition to generating billing information, a variety of reports would be useful in

the process of managing a company's equipment and individual projects. Records
of the history of use of particular pieces of equipment are useful for planning
maintenance and deciding on the sale or scrapping of equipment. Reports on the
cumulative amount of materials and equipment delivered to a job site would be of
obvious benefit to project managers. Composite reports on the amount, location,
and use of pieces of equipment of particular types are also useful in making
decisions about the purchase of new equipment, inventory control, or for project
planning. Unfortunately, producing each of these reports requires manually sifting
through a large number of transfer cards. Alternatively, record keeping for these
specific projects could have to proceed by keeping multiple records of the same
information. For example, equipment transfers might be recorded on (1) a file for a
particular piece of equipment and (2) a file for a particular project, in addition to
the basic transfer form illustrated in Table 14-1. Even with these redundant records,
producing the various desired reports would be time consuming.

Organizing this inventory information in a computer program is a practical and

desirable innovation. In addition to speeding up billing (and thereby reducing
borrowing costs), application programs can readily provide various reports
or views of the basic inventory information described above. Information can be
entered directly to the computer program as needed. For example, the transfer
record shown in Table 14-1 is based upon an input screen to a computer program
which, in turn, had been designed to duplicate the manual form used prior to
computerization. Use of the computer also allows some interactive aids in
preparing the transfer form. This type of aid follows a simple rule: "Don't make the
user provide information that the system already knows." [3] In using the form
shown in Table 14-1, a clerk need only enter the code and quantity for an item; the
verbal description and unit cost of the item then appear automatically. A copy of
the transfer form can be printed locally, while the data is stored in the computer for
subsequent processing. As a result, preparing transfer forms and record keeping are
rapidly and effectively performed.

More dramatically, the computerized information allows warehouse personnel both

to ask questions about equipment management and to readily generate the requisite
data for answering such questions. The records of transfers can be readily
processed by computer programs to develop bills and other reports. For example,
proposals to purchase new pieces of equipment can be rapidly and critically
reviewed after summarizing the actual usage of existing equipment. Ultimately,

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good organization of information will typically lead to the desire to store new types
of data and to provide new views of this information as standard managerial tools.

Of course, implementing an information system such as the warehouse inventory

database requires considerable care to insure that the resulting program is capable
of accomplishing the desired task. In the warehouse inventory system, a variety of
details are required to make the computerized system an acceptable alternative to a
long standing manual record keeping procedure. Coping with these details makes a
big difference in the system's usefulness. For example, changes to the status of
equipment are generally made by recording transfers as illustrated in Table 14-1.
However, a few status changes are not accomplished by physical movement. One
example is a charge for air conditioning in field trailers: even though the air
conditioners may be left in the field, the construction project should not be charged
for the air conditioner after it has been turned off during the cold weather months.
A special status change report may be required for such details. Other details of
record keeping require similar special controls.

Even with a capable program, simplicity of design for users is a critical factor
affecting the successful implementation of a system. In the warehouse inventory
system described above, input forms and initial reports were designed to duplicate
the existing manual, paper-based records. As a result, warehouse clerks could
readily understand what information was required and its ultimate use. A good rule
to follow is the Principle of Least Astonishment: make communications with users
as consistent and predictable as possible in designing programs.

Finally, flexibility of systems for changes is an important design and

implementation concern. New reports or views of the data is a common
requirement as the system is used. For example, the introduction of a new
accounting system would require changes in the communications procedure from
the warehouse inventory system to record changes and other cost items.

In sum, computerizing the warehouse inventory system could save considerable

labor, speed up billing, and facilitate better management control. Against these
advantages must be placed the cost of introducing computer hardware and software
in the warehouse.

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14.4 Organizing Information in Databases

Given the bulk of information associated with construction projects, formal
organization of the information is essential so as to avoid chaos. Virtually all major
firms in the arena of project management have computer based organization of cost
accounts and other data. With the advent of micro-computer database managers, it
is possible to develop formal, computerized databases for even small organizations

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and projects. In this section, we will discuss the characteristics of such formal
databases. Equivalent organization of information for manual manipulation is
possible but tedious. Computer based information systems also have the significant
advantage of rapid retrieval for immediate use and, in most instances, lower overall
costs. For example, computerized specifications writing systems have resulted in
well documented savings. These systems have records of common specification
phrases or paragraphs which can be tailored to specific project applications. [4]

Formally, a database is a collection of stored operational information used by the

management and application systems of some particular enterprise. [5] This stored
information has explicit associations or relationships depending upon the content
and definition of the stored data, and these associations may themselves be
considered to be part of the database. Figure 14-1 illustrates some of the typical
elements of a database. The internal model is the actual location and representation
of the stored data. At some level of detail, it consists of the strings of "bits" which
are stored in a computer's memory, on the tracks of a recording disk, on a tape, or
on some other storage device.

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Figure 14-1 Illustration of a Database Management System Architecture

A manager need not be concerned with the details of data storage since this internal
representation and manipulation is regulated by the Database Manager
Program (DBM). The DBM is the software program that directs the storage,
maintenance, manipulation and retrieval of data. Users retrieve or store data by
issuing specific requests to the DBM. The objective of introducing a DBM is to
free the user from the detail of exactly how data are stored and manipulated. At the
same time, many different users with a wide variety of needs can use the same
database by calling on the DBM. Usually the DBM will be available to a user by
means of a special query language. For example, a manager might ask a DBM to
report on all project tasks which are scheduled to be underway on a particular date.
The desirable properties of a DBM include the ability to provide the user with

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ready access to the stored data and to maintain the integrity and security of the data.
Numerous commercial DBM exist which provide these capabilities and can be
readily adopted to project management applications.

While the actual storage of the information in a database will depend upon the
particular machine and storage media employed, a Conceptual Data Model exists
which provides the user with an idea or abstract representation of the data
organization. (More formally, the overall configuration of the information in the
database is called the conceptual schema.) For example, a piece of data might be
viewed as a particular value within a record of a datafile. In this conceptual model,
a datafile for an application system consists of a series of records with pre-defined
variables within each record. A record is simply a sequence of variable values,
which may be text characters or numerals. This datafile model is one of the earliest
and most important data organization structures. But other views of data
organization exist and can be exceedingly useful. The next section describes one
such general model, called the relational model.

Continuing with the elements in Figure 14-1, the data dictionary contains the
definitions of the information in the database. In some systems, data dictionaries
are limited to descriptions of the items in the database. More general systems
employ the data dictionary as the information source for anything dealing with the
database systems. It documents the design of the database: what data are stored,
how the data is related, what are the allowable values for data items, etc. The data
dictionary may also contain user authorizations specifying who may have access to
particular pieces of information. Another important element of the data dictionary
is a specification of allowable ranges for pieces of data; by prohibiting the input of
erroneous data, the accuracy of the database improves.

External models are the means by which the users view the database. Of all the
information in the database, one particular user's view may be just a subset of the
total. A particular view may also require specific translation or manipulation of the
information in the database. For example, the external model for a paycheck
writing program might consist solely of a list of employee names and salary totals,
even if the underlying database would include employee hours and hourly pay
rates. As far as that program is concerned, no other data exists in the database. The
DBM provides a means of translating particular external models or views into the
overall data model. Different users can view the data in quite distinct fashions, yet
the data itself can be centrally stored and need not be copied separately for each
user. External models provide the format by which any specific information needed
is retrieved. Database "users" can be human operators or other application
programs such as the paycheck writing program mentioned above.

Finally, the Database Administrator is an individual or group charged with the

maintenance and design of the database, including approving access to the stored
information. The assignment of the database administrator should not be taken

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lightly. Especially in large organizations with many users, the database
administrator is vital to the success of the database system. For small projects, the
database administrator might be an assistant project manager or even the project
manager.

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14.5 Relational Model of Databases

As an example of how data can be organized conceptually, we shall describe
the relational data model. In this conceptual model, the data in the database is
viewed as being organized into a series of relations or tables of data which are
associated in ways defined in the data dictionary. A relation consists of rows of
data with columns containing particular attributes. The term "relational" derives
from the mathematical theory of relations which provides a theoretical framework
for this type of data model. Here, the terms "relation" and data "table" will be used
interchangeably. Table 14-2 defines one possible relation to record unit cost data
associated with particular activities. Included in the database would be one row
(or tuple) for each of the various items involved in construction or other project
activities. The unit cost information associated with each item is then stored in the
form of the relation defined in Table 14-2.

TABLE 14-2 Illustration of a Relation Description: Unit Price Information Attributes

Attribute Name Attribute Description Attribute Type Key
ITEM_CODE Item Code Number Pre-defined Code Yes
DESCRIPTION Item Description Text No
WORK_UNIT Standard Unit of Text No
Work for the Item (restricted to allowable units)
CREW_CODE Standard Crew Code for Activity Pre-defined Code No
OUTPUT Average Productivity of Crew Numerical No
TIME_UNIT Standard Unit of OUTPUT Text No
MATL_UNIT_COST Material Unit Cost Numerical No
DATEMCOS Date of MATL_UNIT_COST Date Text No
INSTCOST Installation Unit Cost Numerical No
DATEICOS Date of INSTCOST Date Text No

Using Table 14-2, a typical unit cost entry for an activity in construction might be:

ITEM_CODE: 04.2-66-025
DESCRIPTION: common brick masonry, 12" thick wall, 19.0 bricks per S.F.
WORK_UNIT: 1000 bricks
CREW_CODE: 04.2-3
OUTPUT: 1.9
TIME_UNIT: Shift
MATL_UNIT_COST: 124

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DATEMCOS: June-09-79
INSTCOST: 257
DATEICOS: August-23-79
This entry summarizes the unit costs associated with construction of 12" thick brick
masonry walls, as indicated by the item DESCRIPTION. The ITEM_CODE is a
numerical code identifying a particular activity. This code might identify general
categories as well; in this case, 04.2 refers to general masonry work. ITEM_CODE
might be based on the MASTERFORMAT or other coding scheme. The
CREW_CODE entry identifies the standard crew which would be involved in the
activity. The actual composition of the standard crew would be found in a CREW
RELATION under the entry 04.2-3, which is the third standard crew involved in
masonry work (04.2). This ability to point to other relations reduces
the redundancy or duplication of information in the database. In this case, standard
crew number 04.2-3 might be used for numerous masonry construction tasks, but
the definition of this crew need only appear once.

WORK_UNIT, OUTPUT and TIME_UNIT summarize the expected output for this
task with a standard crew and define the standard unit of measurement for the item.
In this case, costs are given per thousand bricks per shift. Finally, material
(MATL_UNIT_COST) and installation (INSTCOSTS) costs are recorded along
with the date (DATEMCOS and DATEICOS) at which the prices were available
and entered in the database. The date of entry is useful to insure that any inflation
in costs can be considered during use of the data.

The data recorded in each row could be obtained by survey during bid preparations,
from past project experience or from commercial services. For example, the data
recorded in the Table 14-2 relation could be obtained as nationwide averages from
commercial sources.

An advantage of the relational database model is that the number of attributes and
rows in each relation can be expanded as desired. For example, a manager might
wish to divide material costs (MATL_UNIT_COST) into attributes for specific
materials such as cement, aggregate and other ingredients of concrete in the unit
cost relation defined in Table 14-2. As additional items are defined or needed, their
associated data can be entered in the database as another row (or tuple) in the unit
cost relation. Also, new relations can be defined as the need arises. Hence, the
relational model of database organization can be quite flexible in application. In
practice, this is a crucial advantage. Application systems can be expected to change
radically over time, and a flexible system is highly desirable.

With a relational database, it is straightforward to issue queries for particular data

items or to combine data from different relations. For example, a manager might
wish to produce a report of the crew composition needed on a site to accomplish a
given list of tasks. Assembling this report would require accessing the unit price
information to find the standard crew and then combining information about the

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construction activity or item (eg. quantity desired) with crew information.
However, to effectively accomplish this type of manipulation requires the
definition of a "key" in each relation.

In Table 14-2, the ITEMCODE provides a unique identifier or key for each row. No
other row should have the same ITEMCODE in any one relation. Having a unique
key reduces the redundancy of data, since only one row is included in the database
for each activity. It also avoids error. For example, suppose one queried the
database to find the material cost entered on a particular date. This response might
be misleading since more than one material cost could have been entered on the
same date. Similarly, if there are multiple rows with the same ITEMCODE value,
then a query might give erroneous responses if one of the rows was out of date.
Finally, each row has only a single entry for each attribute. [6]

The ability to combine or separate relations into new arrangements permits the
definition of alternative views or external models of the information. Since there are
usually a number of different users of databases, this can be very useful. For
example, the payroll division of an organization would normally desire a quite
different organization of information about employees than would a project
manager. By explicitly defining the type and organization of information a
particular user group or application requires, a specific view or subset of the entire
database can be constructed. This organization is illustrated in Fig. 14-1 with the
DATA DICTIONARY serving as a translator between the external data models and
the database management system.

Behind the operations associated with querying and manipulating relations is an

explicit algebraic theory. This algebra defines the various operations that can be
performed on relations, such as union (consisting of all rows belonging to one or
the other of two relations), intersection (consisting of all rows belonging to both of
two relations), minus (consisting of all rows belonging to one relation and not
another), or projection (consisting of a subset of the attributes from a relation). The
algebraic underpinnings of relational databases permits rigorous definitions and
confidence that operations will be accomplished in the desired fashion. [7]

Example 14-3: A Subcontractor Relation

As an illustration of the preceding discussion, consider the problem of developing a

database of possible subcontractors for construction projects. This database might
be desired by the cost estimation department of a general contractor to identify
subcontractors to ask to bid on parts of a project. Appropriate subcontractors
appearing in the database could be contacted to prepare bids for specific projects.
Table 14-3 lists the various attributes which might be required for such a list and an
example entry, including the subcontractor's name, contact person, address, size
(large, medium or small), and capabilities.
TABLE 14-3 Subcontractor Relation Example

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 Attribute Example
NAME XYZ Electrical Co.
CONTACT Betty XYZ
PHONE (412) xxx-xxxx
STREET xxx Mulberry St.
CITY Pittsburgh
STATE PA
ZIPCODE 152xx
SIZE large
CONCRETE no
ELECTRICAL yes
MASONRY no
etc.

To use this relation, a cost estimator might be interested in identifying large,

electrical subcontractors in the database. A query typed into the DBM such as:

SELECT from SUBCONTRACTORS

where SIZE = Large and ELECTRICAL = Yes

would result in the selection of all large subcontractors performing electrical work
in the subcontractor's relation. More specifically, the estimator might want to find
subcontractors in a particular state:

SELECT from SUBCONTRACTORS

where SIZE = Large and ELECTRICAL = Yes and STATE = VI.

In addition to providing a list of the desired subcontractors' names and addresses, a

utility application program could also be written which would print mailing labels
for the selected firms.

Other portions of the general contracting firm might also wish to use this list. For
example, the accounting department might use this relation to record the addresses
of subcontractors for payment of invoices, thereby avoiding the necessity to
maintain duplicate files. In this case, the accounting code number associated with
each subcontractor might be entered as an additional attribute in the relation, and
the accounting department could find addresses directly.

Example 14-4: Historical Bridge Work Relation

As another simple example of a data table, consider the relation shown in Table 14-
0 which might record historical experience with different types of bridges
accumulated by a particular agency. The actual instances or rows of data in Table
14-4 are hypothetical. The attributes of this relation are:

488
 • PROJECT NUMBER - a 6-digit code identifying the particular project.
• TYPE OF BRIDGE - a text field describing the bridge type. (For retrieval
purposes, a numerical code might also be used to describe bridge type to
avoid any differences in terminology to describe similar bridges).
• LOCATION - The location of the project.
• CROSSING - What the bridge crosses over, eg. a river.
• SITE CONDITIONS - A brief description of the site peculiarities.
• ERECTION TIME - Time required to erect a bridge, in months.
• SPAN - Span of the bridge in feet.
• DATE - Year of bridge completion.
• ACTUAL-ESTIMATED COSTS - Difference of actual from estimated
costs.

These attributes could be used to answer a variety of questions concerning

construction experience useful during preliminary planning.

TABLE 14-4 Example of Bridge Work Relation

Erection
Project Type of Site Time Span Estimated less
Number Bridge LocationCrossing Conditions (Months) (ft.) Actual Cost
200' Valley
Steel Plate
Limestone
169137 Girder Altoona Railroad 5 240 -$50,000
250' High
170145 Concrete Pittsburgh River 7 278 -27,500
Sandy Loam
197108 Arch Allentown Highway 8 256 35,000
135' Deep Pile
Steel Truss
Foundation

As an example, suppose that a bridge is to be built with a span of 250 feet, located
in Pittsburgh PA, and crossing a river with limestone sub-strata. In initial or
preliminary planning, a designer might query the database four separate times as
follows:

• SELECT from BRIDGEWORK where SPAN > 200 and SPAN < 300 and
where CROSSING = "river"
• SELECT from BRIDGEWORK where SPAN > 200 and SPAN < 300 and
where SITE CONDITIONS = "Limestone"
• SELECT from BRIDGEWORK where TYPE OF BRIDGE = "Steel Plate
Girder" and LOCATION = "PA"
• SELECT from BRIDGEWORK where SPAN < 300 and SPAN > 200 and
ESTIMATED LESS ACTUAL COST < 100,000.

Each SELECT operation would yield the bridge examples in the database which
corresponds to the desired selection criteria. In practice, an input/output interpreter

489
program should be available to translate these inquiries to and from the DBM and
an appropriate problem oriented language.

The four queries may represent subsequent thoughts of a designer faced with these
problem conditions. He or she may first ask, "What experience have we had with
bridges of this span over rivers?" "What experience have we had with bridges of
this span with these site conditions? What is our experience with steel girder
bridges in Pennsylvania? For bridges of this span, how many and which were
erected without a sizable cost overrun? We could pose many more questions of this
general type using only the small data table shown in Table 14-4.

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14.6 Other Conceptual Models of Databases

While the relational model offers a considerable amount of flexibility and preserves
considerable efficiency, there are several alternative models for organizing
databases, including network and hierarchical models. The hierarchical model is a
tree structure in which information is organized as branches and nodes from a
particular base. [8] As an example, Figure 14-2 illustrates a hierarchical structure
for rented equipment costs. In this case, each piece of equipment belongs to a
particular supplier and has a cost which might vary by the duration of use. To find
the cost of a particular piece of equipment from a particular supplier, a query would
first find the supplier, then the piece of equipment and then the relevant price.

The hierarchical model has the characteristic that each item has a single
predecessor and a variable number of subordinate data items. This structure is
natural for many applications, such as the equipment cost information described
above. However, it might be necessary to construct similar hierarchies for each
project to record the equipment used or for each piece of equipment to record
possible suppliers. Otherwise, generating these lists of assignments from the
database illustrated in Figure 14-2 would be difficult. For example, finding the least
expensive supplier of a crane might involve searching every supplier and every
equipment node in the database to find all crane prices.

490
Figure 14-2 Hierarchical Data Organization

The network model or database organization retains the organization of information

on branches and nodes, but does not require a tree of structure such as the one in
Figure 14-2. [9] This gives greater flexibility but does not necessarily provide ease
of access to all data items. For example, Figure 14-3 shows a portion of a network

491
model database for a building. The structural member shown in the figure is related
to four adjoining members, data on the joints designed for each end, an assembly
related to a room, and an aggregation for similar members to record member
specifications.

Figure 14-3 Example of a Network Data Model

While the early, large databases were based on the hierarchical or network
organizations, the relational model is now preferred in many applications due to its
flexibility and conceptual simplicity. Relational databases form the kernel for large
systems such as ORACLE or SAP. However, databases distributed among
numerous servers may have a network structure (as in Figure 14-3), with full
relational databases contained at one or more nodes. Similarly, "data warehouse"
organizations may contain several different types of databases and information
files. For these data warehouses, more complicated search approaches are essential,
such as automatic indexing of multi-media files such as photographs.

More recently, some new forms of organized databases have appeared, spurred in
part by work in artificial intelligence. For example, Figure 14-4 illustrates
a frame data structure used to represent a building design element. This frame
describes the location, type, cost, material, scheduled work time, etc. for a
particular concrete footing. A frame is a general purpose data representation
scheme in which information is arranged in slotswithin a named frame. Slots may
contain lists, values, text, procedural statements (such as calculation rules), pointers
or other entities. Frames can be inter-connected so that information may
be inherited between slots. Figure 14-5 illustrates a set of inter-connected frames
used to describe a building design and construction plan. [10] Object oriented data

492
representation is similar in that very flexible local arrangements of data are
permitted. While these types of data storage organizations are active areas of
research, commercial database systems based on these organizations are not yet
available.

Figure 14-4 Illustration of Data Stored in a Frame

493
Figure 14-5 Illustration of a Frame Based Data Storage Hierarchy

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14.7 Centralized Database Management Systems

Whichever conceptual model or database management system is adopted, the use of
a central database management system has a number of advantages and some costs
compared to the commonly employed special purpose datafiles. A datafile consists
of a set of records arranged and defined for a single application system. Relational

494
information between items in a record or between records is not explicitly
described or available to other application systems. For example, a file of project
activity durations and scheduled times might be assembled and manipulated by a
project scheduling system. This datafile would not necessarily be available to the
accounting system or to corporate planners.

A centralized DBM has several advantages over such stand-alone systems: [11]

• Reduced redundancy good planning can allow duplicate or similar data

stored in different files for different applications to be combined and stored
only once.
• Improved availability information may be made available to any
application program through the use of the DBM
• Reduced inconsistency if the same data is stored in more than one place,
then updating in one place and not everywhere can lead to inconsistencies in
the database.
• Enforced data security authorization to use information can be centralized.

For the purpose of project management, the issue of improved availability is

particularly important. Most application programs create and own particular
datafiles in the sense that information is difficult to obtain directly for other
applications. Common problems in attempting to transfer data between such special
purpose files are missing data items, unusable formats, and unknown formats.

As an example, suppose that the Purchasing Department keeps records of

equipment rental costs on each project underway. This data is arranged so that
payment of invoices can be handled expeditiously and project accounts are properly
debited. The records are arranged by individual suppliers for this purpose. These
records might not be particularly useful for the purpose of preparing cost estimates
since:

• Some suppliers might not exist in the historical record.

• Finding the lowest cost supplier for particular pieces of equipment would be
exceedingly tedious since every record would have to be read to find the
desired piece of equipment and the cost.
• No direct way of abstracting the equipment codes and prices might exist.

An alternative arrangement might be to separately record equipment rental costs in

(1) the Purchasing Department Records, (2) the Cost Estimating Division, and (3)
the Company warehouse. While these multiple databases might each be designed
for the individual use, they represent considerable redundancy and could easily
result in inconsistencies as prices change over time. With a central DBM, desired
views for each of these three users could be developed from a single database of
equipment costs.

495
A manager need not conclude from this discussion that initiating a formal database
will be a panacea. Life is never so simple. Installing and maintaining databases is a
costly and time consuming endeavor. A single database is particularly vulnerable to
equipment failure. Moreover, a central database system may be so expensive and
cumbersome that it becomes ineffective; we will discuss some possibilities for
transferring information between databases in a later section. But lack of good
information and manual information management can also be expensive.

One might also contrast the operation of a formal, computerized database with that
of a manual filing system. For the equipment supplier example cited above, an
experienced purchasing clerk might be able to immediately find the lowest cost
supplier of a particular piece of equipment. Making this identification might well
occur in spite of the formal organization of the records by supplier organization.
The experienced clerk will have his (or her) own subjective, conceptual model of
the available information. This subjective model can be remarkably powerful.
Unfortunately, the mass of information required, the continuing introduction of
new employees, and the need for consistency on large projects make such manual
systems less effective and reliable.

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14.8 Databases and Applications Programs

The usefulness of a database organization is particularly evident in integrated
design or management environments. In these systems, numerous applications
programs share a common store of information. Data is drawn from the central
database as needed by individual programs. Information requests are typically
performed by including pre-defined function calls to the database management
system within an application program. Results from one program are stored in the
database and can be used by subsequent programs without specialized translation
routines. Additionally, a user interface usually exists by which a project manager
can directly make queries to the database. Figure 14-6 illustrates the role of an
integrated database in this regard as the central data store.

496
Figure 14-6 Illustration of an Integrated Applications System

An architectural system for design can provide an example of an integrated

system. [12] First, a database can serve the role of storing a library of information
on standard architectural features and component properties. These standard
components can be called from the database library and introduced into a new
design. The database can also store the description of a new design, such as the
number, type and location of individual building components. The design itself can
be composed using an interactive graphics program. This program would have the
capability to store a new or modified design in the database. A graphics program
typically has the capability to compose numerous, two or three dimensional views
of a design, to introduce shading (to represent shadows and provide greater realism
to a perspective), and to allow editing (including moving, replicating, or sizing
individual components). Once a design is completed and its description stored in a
database, numerous analysis programs can be applied, such as:

• structural analysis,
• daylight contour programs to produce plots of available daylight in each
room,
• a heat loss computation program
• area, volume and materials quantities calculations.

Production information can also be obtained from the integrated system, such as:

• dimensioned plans, sections and elevations,

• component specifications,
• construction detail specifications,

497
 • electrical layout,
• system isometric drawings,
• bills of quantities and materials.

The advantage of an integrated system of this sort is that each program need only
be designed to communicate with a single database. Accomplishing appropriate
transformations of data between each pair of programs would be much more
difficult. Moreover, as new applications are required, they can be added into an
integrated system without extensive modifications to existing programs. For
example, a library of specifications language or a program for joint design might be
included in the design system described above. Similarly, a construction planning
and cost estimating system might also be added.

The use of integrated systems with open access to a database is not common for
construction activities at the current time. Typically, commercial systems have a
closed architecture with simple datafiles or a "captive," inaccessible database
management system. However, the benefits of an open architecture with an
accessible database are considerable as new programs and requirements become
available over time.

Example 14-5: An Integrated System Design

As an example, Figure 14-7 illustrates the computer aided engineering (CAE)

system envisioned for the knowledge and information-intensive construction
industry of the future. [13] In this system, comprehensive engineering and
"business" databases support different functions throughout the life time of a
project. The construction phase itself includes overlapping design and construction
functions. During this construction phase, computer aided design (CAD) and
computer aided manufacturing (CAM) aids are available to the project manager.
Databases recording the "as-built" geometry and specifications of a facility as well
as the subsequent history can be particularly useful during the use and maintenance
life cycle phase of the facility. As changes or repairs are needed, plans for the
facility can be accessed from the database.

498
Figure 14-7 Computer Aided Engineering in the Construction Industry
(Reprinted with permission from from Y. Ohaski and M. Mukimo, "Computer-
Aided Engineering
in the Construction Industry," Engineering with Computers, Vol. 1, no. 2, 1985.

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14.9 Information Transfer and Flow

The previous sections outlined the characteristics of a computerized database. In an
overabundance of optimism or enthusiasm, it might be tempting to conclude that all

499
information pertaining to a project might be stored in a single database. This has
never been achieved and is both unlikely to occur and undesirable in itself. Among
the difficulties of such excessive centralization are:

• Existence of multiple firms or agencies involved in any project. Each

organization must retain its own records of activities, whether or not other
information is centralized. Geographic dispersion of work even within the
same firm can also be advantageous. With design offices around the globe,
fast track projects can have work underway by different offices 24 hours a
day.
• Advantages of distributed processing. Current computer technology
suggests that using a number of computers at the various points that work is
performed is more cost effective than using a single, centralized mainframe
computer. Personal computers not only have cost and access advantages,
they also provide a degree of desired redundancy and increased reliability.
• Dynamic changes in information needs. As a project evolves, the level of
detail and the types of information required will vary greatly.
• Database diseconomies of scale. As any database gets larger, it becomes
less and less efficient to find desired information.
• Incompatible user perspectives. Defining a single data organization
involves trade-offs between different groups of users and application
systems. A good organization for one group may be poor for another.

In addition to these problems, there will always be a set of untidy information

which cannot be easily defined or formalized to the extent necessary for storage in
a database.

While a single database may be undesirable, it is also apparent that it is desirable to

structure independent application systems or databases so that measurement
information need only be manually recorded once and communication between the
database might exist. Consider the following examples illustrating the desirability
of communication between independent application systems or databases. While
some progress has occurred, the level of integration and existing mechanisms for
information flow in project management is fairly primitive. By and large,
information flow relies primarily on talking, written texts of reports and
specifications and drawings.

Example 14-6: Time Cards

Time card information of labor is used to determine the amount which employees
are to be paid and to provide records of work performed by activity. In many firms,
the system of payroll accounts and the database of project management accounts
(i.e., expenditure by activity) are maintained independently. As a result, the
information available from time cards is often recorded twice in mutually
incompatible formats. This repetition increases costs and the possibility of

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transcription errors. The use of a preprocessor system to check for errors and
inconsistencies and to format the information from each card for the various
systems involved is likely to be a significant improvement (Figure 14-8).
Alternatively, a communications facility between two databases of payroll and
project management accounts might be developed.

Figure 14-8 Application of an Input Pre-processor

Example 14-7: Final Cost Estimation, Scheduling and Monitoring

Many firms maintain essentially independent systems for final cost estimation and
project activity scheduling and monitoring. As a result, the detailed breakdown of
the project into specific job related activities must be completely re-done for
scheduling and monitoring. By providing a means of rolling-over or transferring
the final cost estimate, some of this expensive and time-consuming planning effort
could be avoided.

Example 14-8: Design Representation

In many areas of engineering design, the use of computer analysis tools applied to
facility models has become prevalent and remarkably effective. However, these
computer-based facility models are often separately developed or encoded by each
firm involved in the design process. Thus, the architect, structural engineer,
mechanical engineer, steel fabricator, construction manager and others might all

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have separate computer-based representations of a facility. Communication by
means of reproduced facility plans and prose specifications is traditional among
these groups. While transfer of this information in a form suitable for direct
computer processing is difficult, it offers obvious advantages in avoiding repetition
of work, delays and transcription errors. A de facto standard for transfer of
geometric information emerged with the dominance of the AUTOCAD design
system in the A/E/C industry. Information transfer was accomplished by copying
AUTOCAD files from user to user, including uses on construction sites to visualize
the design. More flexible and extensive standards for design information transfer
also exist, such as the Industry Foundation Classes (IFC) standard developed by the
International Alliance for Interoperability (See http://www.iai-
international.org/iai_international/) and the "Fully Integrated and Automated
Project Processes" developed by FIATECH (see http://www.fiatech.org/)
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14.10 References
1. Au, T., C. Hendrickson and A. Pasquale, "Introduction of a Relational
Database Within a Cost Estimating System," Transportation Research
Record 1050, pp. 57-62, 1986.
2. Bosserman, B.E. and M.E. Ford, "Development of Computerized
Specifications," ASCE Journal of Construction Engineering and
Management, Vol. 110, No. CO3, 1984, pp. 375-384.
3. Date, C.J., An Introduction to Database Systems, 3rd Ed., Addison-Wesley,
1981.
4. Kim, W., "Relational Database Systems," ACM Computing Surveys, Vol. 11,
No. 3, 1979, pp. 185-211.
5. Mitchell, William J., Computer Aided Architectural Design, Van Nostrand
Reinhold Co., New York, 1977.
6. Vieceli, A.M., "Communication and Coding of Computerized Construction
Project Information," Unpublished MS Thesis, Department of Civil
Engineering, Carnegie Mellon University, Pittsburgh, PA, 1984.
7. Wilkinson, R.W., "Computerized Specifications on a Small Project," ASCE
Journal of Construction Engineering and Management, Vol. 110, No. CO3,
1984, PP. 337-345.
8. Latimer, Dewitt and Chris Hendrickson, “Digital Archival of Construction
Project Information,” Proceedings of the International Symposium on
Automation and Robotics for Construction, 2002."

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14.11 Problems

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 1. Suppose we wish to develop a database consisting of contractor names,
addresses and particular specialties as in Table 14-3.
o Suggest two hierarchical organizations of this data.
o Suggest an alternative relational organization for this data.
o Which organization would you recommend for implementation of a
database?
2. Suggest four reports which could be obtained from the warehouse inventory
system described in Section 14.3 and describe what each report might be
used for and by whom.
3. Suppose that a general contractor wished to keep a historical database of the
results of bid competitions. Suggest (a) the information that might be stored,
and (b) a possible organization of this information.
4. For your suggested database from Problem 3, implement a prototype system
on a spreadsheet software program.
5. Describe a relational database that would be useful in storing the beginning,
ending and all intermediate stages for blockworld robot movements as
described in Problem 6 in Chapter 9.
6. Describe a relational database that would be appropriate for maintaining
activity scheduling information during project monitoring. Be explicit about
what relations would be defined, the attributes in each relation, and
allowable ranges of values.

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14.12 Footnotes
1. See D.F. Rogge, "Delay Reporting Within Cost Accounting System," ASCE
Journal of Construction Engineering and Management, Vol. 110, No. 2, 1984, pp.
289-292. Back

2. The system is based loosely upon a successful construction yard management

system originally for Mellon-Stuart Company, Pittsburgh, PA. in 1983. The authors
are indebted to A. Pasquale for providing the information and operating experience
of the system. Back

3. Attributed to R. Lemons in J. Bentley "Programming Pearls," Communications

of the ACM, Vol. 28, No. 9, 1985, pp. 896-899. Back

4. See Wilkinson, R.W. "Computerized Specifications on a Small Project," ASCE

Journal of Construction Engineering and Management, Vol. 110, No. CO3, 1984,
pp. 337-345. Back

5. See C.J. Date, An Introduction to Database Systems, 3rd ed., Addison-Wesley

Publishing Company, Reading, MA, 1981. Back

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6. This is one example of a normalization in relational databases. For more formal
discussions of the normalizations of relational databases and the explicit algebra
which can be used on such relations, see Date op cit. Back

7. For a discussion of relational algebra, see E.F. Codd, "Relational Completeness

of Data Base Sublanguages," Courant Computer Science Symposia Series, Vol. 6,
Prentice-Hall, l972. Back

8. See D.C. Trichritzis and F.H. Lochovsky, "Hierarchical Data-Base

Management," ACM Computing Surveys Vol. 8, No. 1, 1976, pp. 105-123. Back

9. For a more extensive comparison, see A.S. Michaels, B. Mittman, and C.R.
Carlson, "A Comparison of Relational and CODASYL Approaches to Data-Base
Management," ACM Computing Surveys, Vol. 8, No. 1, 1976, pp. 125-157. Back

10. This organization is used for the central data store in an integrated building
design environment. See Fenves, S., U. Flemming, C. Hendrickson, M. Maher, and
G. Schmitt, "An Integrated Software Environment for Building Design and
Construction," Proc. of the Fifth ASCE Conference on Computing in Civil
Engineering, 1987 Back

11. For a discussion, see D.R. Rehak and L.A. Lopez, Computer Aided
Engineering Problems and Prospects, Civil Engr. Systems Lab., Univ. of Illinois,
Urbana, IL, 1981. Back

12. See W.J. Mitchell, Computer-Aided Architectural Design, Van Nostrand

Reinhold Co., New York, 1977. Back

13. This figure was adapted from Y. Ohsaki and M. Mikumo, "Computer-aided
Engineering in the Construction Industry," Engineering with Computers, vol. 1, no.
2, 1985, pp. 87-102. Back

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