Construction companies are built on a very simple principle: profit equals budgeted costs minus actual costs. At the core, estimate accurately, plan for profit, and maintain your costs, and you have a winning formula that should keep your business profitable. While there are other issues to contend with, like cash flow, supply chain issues, and payment problems, that’s really the gist of a successful business.
So, what could derail such a simple premise? Cost overruns. Cost overruns, in their many forms, can cut deeply into a company’s profit margin, and without a solution, they can ripple through the entire business. Here’s how to avoid cost overruns and stay profitable.
What is an Overrun in Construction?
In the simplest terms, a cost overrun in construction is the result of when the actual costs of a facet of a project exceed the estimated budget for that portion of the project. For example, if a builder budgeted $20,000 for flooring and the actual cost of the flooring was $25,000, there is a cost overrun of $5,000.
Cost overruns can happen for a variety of reasons. They can be the result of underestimating the project from the start, whether poor practices or not truly understanding the project scope. Overruns can be the result of material price fluctuations, changes in design or function, or poor risk management. There are many other reasons why actual costs could exceed budgeted costs.
The issue with cost overruns is that they’re paid for out of someone’s profits. Depending on where the fault lies, the builder or the subcontractor will typically have to eat the overrun or move budgets and timelines to make them back up. In either case, the project has to be completed and the overrun has to be paid for to make it happen.
What is an Example of a Project Overrun?
Cost overruns happen on projects of all types and sizes. One particularly high-profile example is the One57 project in Manhattan. Completed in 2014, the project was a luxury skyscraper full of ultra-luxury apartments. It was estimated to cost $1.5 billion.
Cost overruns ran the actual costs over the $2 billion mark, increasing the amount by over 30%.
Why? Several reasons. For one, construction delays caused by the complex architectural design and the sheer height of the building ballooned actual costs. Also, the ultra-high-end materials chosen by the developer exceeded the original plans. NYC’s market fluctuations in labor and materials weren’t accounted for. And the list goes on.
As a result, overruns seriously inflated the cost of the project. Many of the apartments did sell, but once the luxury real estate market softened, many of the apartments sold for even less than the original $1.5 billion budget accounted for.
Understanding the Average Cost of Construction Overruns
Understanding the average cost of construction overruns requires a lot of data, much of which is only available from larger, high-profile projects. One McKinsey report stated that it’s not uncommon for larger projects to overrun their original budgeted costs by up to 80%.
A number no one wants to fathom.
It’s important to note that several factors influence overruns. First, large projects with hundreds of variables in materials and labor are susceptible to more overruns than smaller projects, resulting in a much higher compound percentage. For residential construction, overruns are often closer to 10% to 20%, but we saw with the One57 project, location and finishes could be a factor—major influences on residential project budgets.
Impacts of Cost Overruns
We already know that cost overruns cut into profits for builders, developers, and subcontractors. But to truly understand why they need to be avoided, let’s look at some of the other impacts:
- Delays and disruptions: The reality is that when the costs start to compound and spiral out of control, the project schedule will, as well. There’s less money to go around to pay invoices, work slows down, overhead costs increase, and legal penalties can loom.
- Corner cutting: Overruns force contractors to make decisions they might not otherwise. Often, quality and safety are the first areas to be compromised, where cheaper materials and rushed work can help recover some of the unexpected costs.
- Reputation hits: Eventually, unchecked overruns can lead to the builder’s, developer’s, or subcontractor’s reputation taking a serious hit. The notion of poor work, the potential legal issues, and the general distaste for the company’s brand will spread, and there will be fewer opportunities available.
Top 5 Causes of Cost Overruns in Construction and How to Avoid Them
Inaccurate Project Estimates
Poor estimates are bound to cause overruns. Inaccurate measurements, poor material price forecasting, and drastically undercutting the competition are surefire ways to create an imbalance between the budget and the actual costs.
Digital tools like construction management software can improve estimate accuracy. Using historical data and real-time updates allows estimators to input and utilize the latest data when creating estimates, predicting the cost more accurately. And, the more often the estimate software is used, the more accurate the estimates become.
Scope Creep and Design Changes
Scope creep occurs when the project’s direction expands beyond the original contract. Rarely does the scope shrink, expanding instead and increasing the cost of delivering the project in terms of materials, labor, and timelines. This can be caused by incomplete planning, client demands and design changes, or miscommunication.
There are some steps contractors can take to limit the damage. For one, set up a formal change order process to manage and approve changes. If a change is necessary, the change order (a new miniature contract) that reflects the cost of the change should be drawn up. Also, clear communication between the builder, the subs, and the client about the costs of the design changes should be implemented from the start.
Poor Project Planning and Scheduling
Poor project planning and scheduling is a major issue. Delivering the project on time and within budget requires a clear roadmap that can absorb small delays and setbacks.
Utilizing digital tools to monitor budgets, project progress, timelines, and allocate resources can help develop that clear road map. Builders can easily monitor progress and make adjustments to ensure the project stays on track using construction management software like Beam.
Beam allows contractors to track progress and expenses against their budget in real-time to see estimates vs. actuals and make changes before a cost overrun occurs. And, by using historical data, the more the software is used, the more accurate it becomes.
Inefficient Resource Management
Poor resource management routinely results in shortages and delays, both of which create overruns. Whether it’s not having enough labor on one aspect of the project, not planning the most efficient use of a piece of equipment, or simple labor shortages, the costs can be significant.
This is another area where construction management software can help avoid an overrun. Real-time resource tracking, improved scheduling, and effective forecasting give teams the tools they need to plan and manage resources more effectively, reducing errors and allowing the team to work on tighter margins.
Delays in Procurement and Permits
When it comes to residential construction, the permitting process itself can cause overruns due to delays and design fees. If the local permitting body doesn’t like a plan, they could easily delay the process and request design changes. Also, the delays that supply chain issues and poor coordination can cause will drive up costs.
Start the permit and procurement processes early. Maintain strong communication with both the suppliers and the permitting bodies, as well. Starting early, building in a bit of a buffer in the schedule, and constantly communicating can help avoid these overruns.
Conclusion
Avoiding cost overruns in construction requires careful planning, accurate estimation, and proactive management. Identifying the common causes—such as inaccurate estimates, scope creep, poor planning, inefficient resource management, and delays in procurement or permits—is critical to keeping projects on time and within budget.
By adopting best practices, such as using formal change order processes and leveraging modern construction management software, contractors can significantly improve cost control and resource allocation. This not only reduces the risk of overruns but also enhances overall project efficiency and profitability. Taking these steps will ensure smoother project execution, protect profit margins, and safeguard your company’s reputation in a competitive industry.
If avoiding cost overruns is a priority for your business, Beam's solution could be a good fit. To learn more, schedule a demo with our team today.