By Matti Siemiatycki
Municipalities across Canada are in the midst of an infrastructure building boom. After decades of underinvestment, billions of dollars are being promised and spent to rehabilitate existing assets and construct new transportation, water, waste, public housing, civic, and recreation facilities.
However, over the past few years, the media has tallied millions of dollars in rising costs and years in schedule delays on municipal infrastructure projects, such as the construction of the Spadina Subway extension, the redevelopment of Union Station, the purchase of new TTC streetcars, the construction of Lansdowne Park Stadium in Ottawa, and the building of new city halls in Vaughan and Guelph. International evidence suggests the bigger the project, the more likely it will go over budget and miss its deadlines. The outcomes include government budget deficits and a loss of public confidence that the government can meet its commitments.
A new paper by the Institute on Municipal Finance and Governance (IMFG)—Cost Overruns on Infrastructure Projects: Patterns, Cause, and Cures—shows that the causes of cost overruns are not merely technical. There are deep psychological and political economic factors that also contribute to the persistence of this phenomenon. Local governments need to develop effective strategies to plan and deliver major infrastructure projects.
How accurate are cost estimates?
Procurement problems on large infrastructure projects are a global epidemic. They affect projects conducted by national, provincial, and local government, and by private-sector organizations; they are a feature of a wide diversity of infrastructure project types; and they have been stubbornly persistent throughout history. Cost escalations and schedule slippage can occur during preliminary project planning as the initial concept is priced and the design refined; from the time that the project is approved until a final contract is signed; during the actual construction period until substantial completion is reached; and after completion if deficiencies must be fixed.
International research shows most infrastructure mega-projects experience cost escalations, but the overruns depend on project type and size. In the transportation sector, Bent Flyvbjerg, Nils Bruzelius, and Werner Rothengatter conducted the largest study of cost overruns (2003’s Megaprojects and Risk: An Anatomy of Ambition) on a sample of 258 major roads, tunnels, bridges, urban transit, and interurban rail projects in 20 countries on five continents. Each mega-project cost $100 million or more, and most were the biggest, highest-profile, and most complex transportation projects conducted in the jurisdiction at the time. The study concluded that nine out of 10 mega-projects experienced a cost overrun, and the average cost escalation was 28 per cent. This pattern of cost escalation was common across all countries in the study and was unchanged over the 70 years for which data was available.
Cost overruns are also a persistent problem on mega-projects in other sectors. In the energy sector, a 2014 study in the journal, Energy Policy by Flyvbjerg and Atif Ansar found that of 245 large hydro dam projects in 65 countries, the cost escalated on average by 90 per cent between the final approved budget and the completed project. There was no improvement in accuracy over the 70 years of data the study covered.
Studies of smaller, more routine construction and maintenance projects in the transportation sector show that cost estimates for this type of work tend to be more accurate. As three recent studies in the transportation sector found, only about half of all small road projects experienced a cost overrun, and the average escalation ranged from four to 9.5 per cent. A 2006 study of cost overruns on Canadian transportation projects conducted by Joseph Berechman and Qing Wu examined 163 routine highway, bridge, and tunnel projects on Vancouver Island, and found that eight out of 10 had cost overruns.
It appears that while overruns still occur, cost estimates tend to be more accurate for smaller, simpler projects that can be completed over a shorter period than for mega-projects, and for projects that involve fewer sub-contractors. These routine projects are also less likely to get caught up in politicized decision-making processes that can surround a high-profile mega-project.
Why do overruns persist?
Explanations for cost overruns can be grouped into three categories: technical challenges, over-optimism, and strategic misrepresentations:
Technical challenges include scope changes and change orders, problems coordinating a large cast of contractors and subcontractors, increased labour or material costs, inaccurate forecasting, and poor monitoring of projects. Since most of these factors could be anticipated and controlled, however, one might expect that budgeting and scheduling would improve over time as those who manage mega-projects gain more experience, but this is not the case.
For decades, researchers studying human behaviour have found that people are prone to “planning fallacies” or optimism biases, whereby they underestimate the time and cost to complete a task. The tendency of individuals to accentuate the positive is amplified by forces within organization, and these tendencies are compounded in situations in which the results of a plan will not be known for many years, staff turnover is quick, and there are few personal consequences for underestimating project costs. Faced with the prospect of making an optimistic forecast in the short-term to get a project started or an accurate long-term forecast, the favourable short-term forecast usually prevails.
When project construction is entirely financed by government, the costs of overruns and schedule delays deemed the responsibility of government are borne by taxpayers rather than those who planned, approved, and promoted the project. Until recently, few government employees were ever fired over projects that experienced cost overruns. Politicians and project promoters have an incentive to underestimate the costs of their preferred infrastructure plans to make them palatable to voters, and contractors competitively bidding for projects may strategically underestimate costs, knowing that once they win the job, they can drive up the price through change orders.
Cures for overruns
Cost overruns on large-scale projects are a persistent problem with a diversity of complex technical, psychological, and political economic causes. In response, measures are required that address the varied causes of escalating project costs:
Enhance performance monitoring, reporting, and information sharing
The world is in the midst of a big data and analytics revolution, yet infrastructure mega-project delivery remains a sector that has been largely untouched by this trend. Cities should require that data on procurement performance be collected for all infrastructure projects over a minimum cost threshold. Data collection should be coordinated through a central department and conducted through a single software application. Inputting data as the project is ongoing would reduce the costs associated with retrieving this information after the fact, and make it possible to account for changes in budgets over time that can make it difficult to accurately interpret a project’s success.
Evaluation systems are by no means a novel concept in Ontario municipalities, especially as they pertain to measuring vendor performance. Many municipalities include formal contractor performance evaluations as part of their tendering policies. In 2013, for instance, the City of Toronto mandated that the general contractor on any city construction job be evaluated using a common Contractor Performance Evaluation Form. Over time, this performance tracking system would develop a very large dataset that could be statistically analyzed to show trends in the dynamics of infrastructure delivery costs, quality, and cost overruns. In time, cities could develop predictive models that estimate the likelihood of cost escalations under various conditions.
Reward good performance
Long-term, sustained improvements in performance are greatest when incentives reward individuals or firms that rank at the top of their league—while penalizing those that fail to meet performance expectations. One approach that has gained international interest is the implementation of formal prequalification systems, which give firms with a good track record an improved chance of obtaining future contracts. Although such systems have been used to drive up the quality of infrastructure procurement, in Canada, they are commonly designed so that as long as a firm meets the minimum standard required, it is eligible to bid for a government construction job. In Hong Kong and Singapore, by comparison, firms found to be consistently high-performing in terms of quality construction and budget certainty on previous jobs are assigned extra points when their bids are evaluated. This means high-performing firms can beat out low-performing firms even if their bids are scored slightly worse or cost a little more.
Enhance the management capabilities of staff
Weak project management by city staff has been identified as a common source of cost overruns. There is a growing need for city government staff with specialized skills to manage the complex relationship between the public and private sectors. Necessary skills include the ability to write effective requests for proposals that clearly articulate the client’s demands; to manage competitive tender processes designed to select firms based on best value rather than lowest bid; to draft enforceable contracts that clearly transfer the risk if budget expectations are not met or change orders are requested by the contractor; to oversee change orders initiated by government; and to use conflict resolution approaches when tensions between partners arise. In addition, sufficient resources must be available to support the function of contract drafting, management, and monitoring, such as effective training programs.
Apply state-of-the-art forecasting techniques
Numerous innovative techniques have been designed to deliver more accurate ex-ante project cost estimates. Benchmarking a project under review against a representative reference class of recently completed projects has been proposed to assess probable project costs and overrun magnitude more realistically than developing forecasts based on internal agency predictions of costs.
In line with such an approach, the British government has provided guidance on applying “optimism uplifts” to transportation project cost estimates, which are based on empirical measures of cost overruns on past projects in the sector. This method of reference class forecasting is enabled by data collected through the implementation of a rigorous performance monitoring system.
Make selective use of public-private partnerships (P3s)
Having a significant amount of private capital at stake during the construction of a project provides an incentive for the contractor to meet performance objectives and gives greater leverage to the government client to enforce the terms of the contract. Recent provincial government P3s in Ontario have delivered a high level of cost certainty. A study commissioned by Infrastructure Ontario found that of 30 projects delivered since 2007 by the provincial government agency, 29 were completed below budget and 22 were opened on time.
Yet the value and suitability of P3s for municipalities has limitations, and this model of procurement should be applied with care. Due to the high costs of structuring and executing a P3 deal, P3s make sense for projects with a capital value of more than $50 million. This excludes many smaller municipal projects. Many municipal infrastructure projects are also closely integrated within an existing network of service and thus, there is no effective means of introducing private operations.
In practice, P3s are like purchasing an insurance policy against the likelihood of a cost overrun. The government pays a significant premium up front to ensure cost certainty and protect against a far larger cost exposure if the budget increases as the project progresses. Purchasing this type of insurance through a P3 delivers value only for the largest, most complex, and riskiest municipal infrastructure projects, for which major cost overruns are a likely occurrence. The implementation of performance monitoring systems that systematically track patterns of cost overruns across a large number of municipal projects would provide empirical evidence to identify projects that are appropriate candidates for P3s.
The outstanding question arising from this analysis is whether any of the main stakeholders involved in municipal infrastructure delivery—politicians, city staff, and private firms—have an interest in moving beyond tough talk about cost overruns to implement strategies that actually address this problem. Effective strategies do exist and are being implemented to measure and incentivize effective management of large public infrastructure projects elsewhere in the world. Is there a will to implement these strategies at the municipal level in Canada?
Matti Siemiatycki is an associate professor in the Department of Geography and Planning at the University of Toronto. The IMFG is an academic research hub and non-partisan think tank based in the Munk School of Global Affairs at the university.
This feature is based on an IMFG Perspectives Paper—Cost Overruns on Infrastructure Projects: Patterns, Cause, and Cures—which can be accessed at bit.ly/imfg-roadmap.