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Validation — success key in lump-sum

projects
contractor's perspective

CONFERENCE PAPER ǀ Cost Management, Estimating ǀ 3 March 2008

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Pillai, Madhu P.

How to cite this article:

Pillai, M. P. (2008). Validation — success key in lump-sum
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projects: contractor's perspective. Paper presented at

PMI® Global Congress 2008—Asia Pacific, Sydney, New
South Wales, Australia. Newtown Square, PA: Project
Management Institute.

Abstract ADVERTISEMENT

Cost is not something that supports business, it is the

business. So effective control of it is an absolute necessity
for any project success. Cost starts with estimation, so
estimation has major significance in the entire project life
cycle. On many projects, the first response from an assigned
project manager is more than likely to be negative, because
of the bid pricing, and the project will be described as one of
those potential commercial disasters from day one.
However, what these project managers generally fail to
understand and appreciate is the necessity of a proper and
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Introduction
By LeBard, Ed ǀ Imagine you
Cost management is the business. So it is not to be tasted or discover your construction
swallowed. It needs to be chewed and digested. Ultimately, project has been using
business success is the combination of brain and materials outdated pricing estimates.
When the current figures
—the more brain you use the less material you need.
come in, you realize that
 There's an evolution underway! Project heads are becoming you've derailed your project
business leaders or facilitators. Today's project managers do and your relationship with…
not simply execute what the CEOs dictate. They always see
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CONFERENCE PAPER ǀ
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managers are appreciating the shift in the way project
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networks and analogous
Cost management starts with estimating, which emphasizes estimating to determine
the significance of estimation in project management. This the project budget
paper emphasizes “validation” with relation to estimating.
The base cost estimate and its validation are highly
By Vargas, Ricardo Viana ǀ
significant to the success of any project. For the owner
At times, some problems
(client), if the cost estimate is not accurate, financial return
and challenges in the
from capital investment may not be realized and other
project environment are too
deserving projects may not have been funded. For the
complex with too many
contractor, the estimation accuracy has different impacts for
variables to allow for the use
different contracting situations. On a lump sum project, the of a traditional computer
profit margin totally depends on the accuracy of the algorithm to calculate the
estimate. The loss from an inaccurate estimate, especially project's results.…
on a large project, can potentially put a contractor out of
business. On cost-plus projects, the direct economical risk is
less, but can severely damage a contractor's reputation. This ARTICLE ǀ Scheduling,
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paper focuses on the contractor's perspective. March 2015

PM Network
Bid Estimate and Limitations on Its Accuracy
Imposed deadline
The discussion in this paper about the base bid estimate syndrome
does not intend to cover the concepts and methodologies of
estimating. However, limitations faced by the bidding team By Heerkens, Gary ǀ
are well appreciated here. Estimation done during the Contributing editor Gary
bidding stage is generally of low accuracy, due to many Heerkens encourages
reasons, such as: practitioners to learn to
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generate bottom-up
Limited information from bid package in terms of quality schedule and cost estimates
and completeness, leading to many assumptions that deliver realistic goals to
Too much information to comprehend and analyze in senior management,
short duration responsibilities that seem
to…
A small team with limited expertise in all engineering
disciplines
ARTICLE ǀ Cost Management,
Company business strategies, like winning a client with Estimating, Technical Skills ǀ April
future business potential 2012

However, the bidding team needs to take all possible PM Network

measures and care to minimize the errors, using historical Estimating on the go
data on successful and failed projects in terms of cost and By Fretty, Peter ǀ Regardless
schedule, outcomes of lessons learned exercises on of industry, cost overruns
previous projects, pulses in the regional and global are a common concern for
economic scenarios, and so forth. project managers. The
evolution of estimating
Apart from establishing the project budget, an estimate plays software is helping to
a major role in monitoring the budget during project address the problem. This
execution. So the estimate must provide accurate article discusses recent
information to allow for scheduling, cost monitoring, and trends…
progress measurement during execution.

Benchmarking and reconciliation with past similar projects CONFERENCE PAPER ǀ Cost
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during estimating will ensure credibility. Major discrepancies 2011
need be to be explained in detail or attributed to the
Crash with confidence
peculiarity of the project. Some could even be attributed to
the strategic importance of the particular project to the
company. Reconciliation can be generally presented at a By Kelly, Éamonn V. ǀ
higher level, with supporting documentation made available Project management is
for better comprehension by the project team, if required. about optimizing time, cost,
 With the limitations during bid estimate, a validation of the and quality performance on
estimate is essential before commencing the project projects. These three
execution. The validation needs to cover the following variables are intrinsically
aspects of the bid estimate: linked. Changes in
requirements of these
Quality or accuracy of the estimate variables frequently occur…
All required information for project controls
Presentation in an understandable way for the project
team members on the client's and contractor's sides

Basis of Estimate

The “Basis of Estimate” (BOE) needs to be unambiguous

and comprehendible for all who would be using it in the
project execution team.

The BOE document is important, as the dollar value is

meaningless without knowing the basis. BOE generally
includes the design basis, planning basis, cost basis, and
risk basis of the estimate.

Design Basis: This section needs to cover the overall scope

of the project in summary. Specific inclusions, and more
importantly, specific exclusions of items or facilities need to
be clearly documented. Moreover, this section needs to also
cover all assumptions made during the bidding stage due to
limited information and constraints of time and resources. If
not managed carefully, the design/detailed engineering
phase has the potential to significantly impact on
procurement and construction, which in turn has direct and
irreparable impact on cost and schedule. Experienced
project managers agree that it's very difficult to win when
change control becomes a political battle escalated to upper
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management. So the success of any project is highly

dependant on the clarity of the design basis.

Planning Basis: This section needs to cover specific

information about all aspects of the project, including
contracting and subcontracting strategies during
engineering, procurement, construction, and commissioning
phases. It needs to also cover information about resources,
length of the workweek, use of overtime, use of shift work,
the project schedule, and key milestone dates.

Cost Basis: This section needs to cover the sources of all

major equipment and bulk material pricing, labour rates
(including engineering, fabrication, construction, and
commissioning), allowances included, assumptions on
productivity, and so forth. Utmost clarity is required on the
pricing strategies used for high-valued capital equipment,
and it needs to be well supported with the necessary back-
up documentation.

Risk Basis: Every estimate is a prediction of probable costs,

and hence involves uncertainty and risk. This section of the
BOE document needs to clearly identify key areas of risks
and opportunities, and document how the contingency is
planned.

Handover to Project Team

As a kick-off for the validation process, the
bidding/estimating/business development/marketing team
will hand over the bid documentation, right up to job award,
to the project team, led by the project manager. This shall be
 a detailed formal session lasting from 8 to 20 hours,
depending on the size and complexity of the project.

The project team must have become initially familiar with the
scope before this handover session. This will enable the
project team to use the handover meeting to get a clear
understanding of the project.

Project Handover on the Client's End

Handover happens on the client's side as well, to the project

execution team. It is entirely possible that the client's
execution team doesn't have even a single member from the
bid handling team. So correspondences during the bidding
stage about bid clarifications are very important. In many
cases verbal agreements reached during bid stage would
not help a situation of a scope ambiguity with commercial
impact. Moreover, assumptions made during estimating,
along with any verbal commitment on quality or schedule
adjustments, need to be documented clearly.

Validation Process
Some experienced project managers use rules of thumb to
verify estimates. However, formal validation is the
professional approach. Reassessment of the risks and
contingencies is essential, as the project manager has to live
with and even defend it in subsequent reviews with the
upper management. There are many elements of
construction projects that add to the pressure to finish a
project successfully for the owner and contractor, including:

Design changes or defects

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Aggressive schedules
Competitive bidding
Difficult contracts
Unrealistic fast-tracking concepts
Major scope changes
Late site access
Unforeseen site conditions
Environmental issues
Uncertain labour productivity
Ineffective project controls
Differing site conditions
Budget limitations
Labour shortage
The validation process should address all applicable
elements of the specific project, not limited to the above
listing. The validation process at a contractor's end starts
when formal or informal information is received from the
client about winning the project. The process starts with the
assessment of the project as a viable business opportunity
meeting the contracting company objectives. It is then
followed by a detailed validation exercise leading to no or
minimum risk, no blame, pre-construction planning, and a
business plan to meet the project objectives.

One of the major early steps in the process is the review of

the BOE document for its correctness and completeness.
Any ambiguity felt needs to be discussed with the bid
 estimating team and if necessary, with the client. In some
cases, the research on the identified ambiguities can lead to
major changes in the project execution, with or without
commercial impact.

A quick check of the bid estimate is very important during the

early steps of validation. This careful review must verify
whether the estimate followed standard guidelines accepted
by company norms and procedures. This includes verifying
the following:

Proper estimating methods, techniques, and procedures

were used.
The estimate summary and detail are organized and
presented in the proper format.
Estimates' back-up information is organized properly.
All allowances and factors are appropriate.
Other major steps in the validation are validating the project
from drawings, setting up a cost control system, establishing
a realistic project execution plan, determining a revalidation
schedule during the project life cycle, and so forth. Moreover,
specific focus needs to be given to the following:

Verification of engineering cost – because engineering

decides 80% of overall project cost elements, there
should be a realistic approach for engineering cost.
Agreement with the authorities at the right level about
home office-related costs
Final constructability review
Construction indirect costs (temporary facilities,
construction equipment, tools, services, consumables,
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and so forth)
Start-up and commissioning cost elements
International labour adjustments for productivity, wage
rates, working hours, and so forth
Reduced productivity during regional holidays and
festival seasons
Material cost adjustments for local and globally sourced
materials
Currency fluctuations
Another important step in validation is comparing key
matrices from the estimate. Major discrepancies must be
explained by the particular circumstances of the estimated
project. Some commonly compared matrices are:

Percentage administration costs

Percentage engineering/design costs
Equipment to total field cost ratio
Equipment to total project cost ratio
Cost per piece of equipment
Labour hours per piece of equipment
Discipline-level ratios (such as cost per diameter inch of
piping, cost per cubic yard of concrete)
This exercise will be effective only if accurate historical data
is maintained for past projects. The current estimate gains
credibility by comparing it with earlier estimates and clearly
explaining the differences and reasons for differences.
 Reconciliation can be presented at a high level without too
much detail.

Apart from all the above, strategic reviews of the estimate

have to be done at various levels of corporate management,
if required. The number of upper management reviews and
the level of management they are presented to typically
varies with the strategic importance and total estimated cost
of a particular project.

Validation Team

As the project validation has to be done during the very

beginning of the project, key personnel need to be
assembled to handle this task. A typical validation team
comprises the following personnel:

Project manager
Engineering manager
Construction manager
Planning manager
Procurement manager
Quality manager
HSE manager
Generally, no member from the bidding team would be
included in the validation team full-time. However, the
bidding team has a great role to play in the success of the
validation process, with timely clarifications of any ambiguity
the validation team finds in the bid estimate.

A new trend gaining importance on the Engineering,

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Procurement & Construction contractor's side is “Project

Team on Shelf,” where a very small group of potential core
project management team is involved in the bidding stage of
major projects with more than a 60% chance to win. This will
ensure effective and seamless handover from the business
development team to the project execution team, thereby
making the first validation highly accurate and reliable.

Timing Validation

It's a prudent management practice to validate at different

stages of the project. For any project more than one year
long, the first validation needs to be completed within two
months. The second validation can happen only after the
engineering is fairly advanced. This stage of the validation is
extremely important and even critical, as 80% of project cost
is controlled through the engineering design.

Opportunities and Risks

Validation should give a very clear picture of the
opportunities and risks in these areas:

Opportunities and profit: Opportunities need to be identified

at the earliest and handled for timely and effective
capitalization. Good examples are achieving client consent
for a non-approved vendor for major high-value equipment,
or a different subcontracting strategy for a major area of
work. Many opportunities can lead to additional business
(sales), generally with higher returns than the rate expected
from the base bid. Each potential opportunity should be
identified, quantified, and valued.
 Risks: As we saw earlier, the accuracy of the bid estimate is
limited for many reasons, and the contingency plan may not
always cover all risks. The validation team needs to highlight
any area where the company is exposed to liabilities. Each
major risk item should be identified, qualified, and costed.

During validation, if the team comes across a major mistake

in the original bid estimate, the project manager needs to
have the courage to go back to the client to revise the bid.
Most professional clients are likely to absorb such a situation
after due evaluation and analysis.

Business plan: The validation team needs to put together a

clear business plan, which would be a revised version of the
basic plan that the sales or business development team
handed over by to the project team. This should include the
following, at the minimum:

Items and issues to be arranged

Clearly defined ownership
Timetable for achievement
A clear-cut plan with ownership from project
management team for any outsourced activities like
design/detailed engineering, subcontracts, etc.

Effect of Unbalanced Bid

Unbalancing the bid means bidding the cost items that would
be completed early in the project at amounts higher than the
normal and pricing the items to be completed in later stages
at lower than normal. Though front-end loading is mainly
practiced in unit price contracts, conceptually it has become
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a part of the pricing strategy for lump-sum projects as well.

Here the contractor does unbalancing on the schedule of
values, which is used for determining progress payments.
The validation team must closely look at this aspect while
finalizing the cost projection system (discussed later in this
paper). Front loading in lump-sum projects lead to lower
cash inflow towards the end of the project. If the bid estimate
was unbalanced for strategic reasons it needs to be formally
documented in the handover from the business
development/marketing team to the project team.

Acceleration Costs

In today's situation on global investment across various

sectors, the world's manufacturing capacities and human
resource bank are not able to meet the demand. Aggressive
schedules add fuel to this fire. All these contribute to the
acceleration cost for meeting or beating the baseline
schedule. Major cost elements to address such situations
are special shipping (such as air lifting) costs, risk of quality
compromises, re-work, shift work, overstaffing, overtime, and
so forth. These have to be considered while arriving at
contingencies allowed. Overtime, overstaffing, and shift work
lead to significant drops in productivity levels. Overtime is
often preferred, as it can produce a higher rate of progress
without major coordination problems.

Cumulative Impact

Some projects have the potential for productivity loss due to

multiple changes arising in between. It can happen due to an
unreasonable number of variations issued with or without
 direct commercial implications. Sometimes these variations
together can make a synergetic disruption of the work that
will be much more than the impact of individual variations.
These disruptions can be very expensive in terms of reduced
productivity or increased cost of performance. The validation
team needs to consider this possibility.

Project Execution Plan

The validation team needs to revisit the project execution

plan. The sequence of major activities can sometimes be
changed for easier execution and economic procurement.
Moreover, an activity envisaged for subcontracting may be
found not the best option during validation, due to many
reasons. The project execution plan needs to be analyzed
carefully. Many times, experienced project managers come
up with better and more logical sequencing and grouping of
activities to optimize on equipment and manpower. The plan
has to be studied along with the baseline schedule, so that
some specific activities do not fall during extreme climatic
conditions. Though such situations cannot be fully avoided,
all efforts should be made to minimize it. Subcontracting
strategies should be carefully analyzed for the best “make or
buy” decisions.

Cost Projection for the Project

The validation team needs to put together a realistic cost

projection for the project, which can be used during and after
the project execution phase for:

Cost and sales monitoring

Establishing initial cash flows
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“What ifs” for the project manager to handle specific

scenarios
Bidding of future projects
Cost figures are validated in this document from time to time
based on improved clarity on the project deliverables. The
cost projection for the project will be refined to a high degree
with the approval of various design and detailed engineering
deliverables. Big EPC companies have a fairly organized
and professional approach to the cost projection system.
However, in many companies most of the core project team
members are not well exposed to it.

Responsibility Matrix

The right people at the right levels should be ensured in the

Organization Chart. If the right person is not available for the
project, validation should consider budgeting for necessary
training and development activities. Companies that are
conservative on developing and empowering their human
resources often fail to understand that it's more expensive to
keep an untrained worker than to lose a trained one.
Empowered employees with unambiguous scope can
minimize the risks of micro-management, which is a killer on
small projects and self-defeating on larger ones.

Human Resource Replacement Cost

For an EPC company, one of the major assets is human

resources. In today's global scenario, employee turnover is
accepted as a reality and no more considered as a threat.
 So organizations have started putting effective systems in
place to mitigate the damages due to employee turnover. As
we say in project management, “you cannot manage what
you cannot measure”; it leads us to conclude that we need to
measure the cost of human resource replacement in order to
effectively manage it. Some major elements of employee
turnover are discussed here.

By definition, a project is a “temporary endeavor,” and when

key personnel are lost during the short duration of any
project, the damage becomes highly expensive to repair.
Globally, the supply and demand gap in the EPC sector is
highly in the employee's favour, and many organizations are
facing “brain drain.”

All organizations may not necessarily be able to develop a

system for identifying, quantifying, monitoring, and
controlling the “human resource replacement cost.”

Major EPC companies have a large number of educated or

skilled personnel and many people occupying similar
positions. Such people-intensive organizations invest heavily
in their labour force, and qualify for having human resource
accounting practices. The validation exercises at any stage
have to look at potential human resource replacement costs.

It is not easy to put a value on the loss of efficiency and

reduced productivity prior to employees' separation (mainly
after they have given notice). A practical approach will be to
start, based on standardized norms followed in the project
estimate, and subsequently fine tune it during each
separation event.

Legal/HSE Aspects
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Due consideration should be given to all legal and HSE

aspects applicable geographically. Care should also be
taken to ensure HSE requirements are considered based on
the minimum requirements from local regulations, company
standards, or internationally accepted best practices.

Conclusion
Since validation itself is a cost element and calls for specific
resources, many times it doesn't receive the priority it
deserves. Senior management commitment is crucial to get
the best return from validation exercises. At the same time, it
is important here to emphasize Pareto's theory that 80% of
project's ultimate outcome is result of the higher impact from
only 20% of components. So areas of thrust during detailed
validation must be identified carefully, and it depends to a
great extent on the skills and knowledge of the team.

References
Chitkara, K.K. (2004). Construction project management.
New Delhi, India: Tata McGraw-Hill Publishing Company.

This material has been reproduced with the permission of the

copyright owner. Unauthorized reproduction of this material is
strictly prohibited. For permission to reproduce this material,
please contact PMI or any listed author.
©2008, Madhu P. Pillai
Originally Published as a part of 2008 PMI Congress
Proceedings – Sydney, Australia
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