A cost overrun, also known as a cost increase or budget overrun, is an unexpected cost incurred in excess of a budgeted amount due to an under-estimation of the actual cost during budgeting. Cost overrun should be distinguished from cost escalation, which is used to express an anticipated growth in a budgeted cost due to factors such as inflation. Cost overrun is common in infrastructure, building, and technology projects. A comprehensive study of cost overrun published in the Journal of the American Planning Association in 2002 found that 9 out of ten construction projects had underestimated costs. Many major construction projects have incurred cost overruns. The Suez Canal cost 20 times as much as the earliest estimates; even the cost estimate produced the year before construction began underestimated the project’s actual costs by a factor of three.
Three types of explanation for cost overrun exist: technical, psychological, and political-economic.
- Technical explanations account for cost overrun in terms of imperfect forecasting techniques, inadequate data, etc.
- Psychological explanations account for overrun in terms of optimism bias with forecasters.
- Finally, political-economic explanations see overrun as the result of strategic misrepresentation of scope or budgets.
All three explanations can be considered forms of risk. A project’s budgeted costs should always include cost contingency funds to cover risks (other than scope changes imposed on the project). As has been shown in cost engineering research, poor risk analysis and contingency estimating practices account for many project cost overruns. Numerous studies have found that the greatest cause of cost growth was poorly-defined scope at the time that the budget was established. The cost growth, or overrun of the budget before cost contingency is added, can be predicted by rating the extent of scope definition, even on complex projects with new technology. Professor Bent Flyvbjerg of Oxford University held the view that big public-works projects almost always have cost overruns due to strategic misrepresentation —‘that is, lying’, as he defines the term.
Cost overrun is typically calculated in one of two ways:
- either as a percentage, namely actual cost minus budgeted cost, in percent of budgeted cost;
- or as a ratio of actual cost divided by budgeted cost.
For example, if the budget for building a new bridge is N100 million, and the actual cost is N150 million, then the cost overrun may be expressed by the ratio 1.5, or as 50 percent.
References
Flybjerg, Bent (2005). Policy and planning for large infrastructure projects: Problems, causes, cures. World Bank Publications, pp. 4–5. Docket WPS3781 (Report).
Flyvbjerg, Bent (2008). Curbing optimism bias and strategic misrepresentation in planning: reference class forecasting in practice. European Planning Studies (Rutledge) 16 (1): 3–21. doi:10.1080/09654310701747936. ISSN 0965-4313. http://www.sbs.ox.ac.uk/ centres/bt/Documents/Curbing%20Optimism%20Bias%20and%20Strategic%20Misrepresentation.pdf.
Flyvbjerg, Bent; Holm, Mette Skamris; Buhl, Søren (Summer 2002). Underestimating costs in public works projects: Error or lie? Journal of the American Planning Association (Chicago: American Planning Association) 68 (3): 279–295. ISSN 0194-4363. http://flyvbjerg.plan.aau.dk/JAPAASPUBLISHED.pdf. Retrieved 2010-10-16.
Hackney, John W. (1991). Humphreys, Kenneth K.. (ed.). Control and management of capital projects. american association of cost engineers (2nd ed.). New York: McGraw-Hill. ISBN 9780070012592. OCLC 123212738.
Merrow, Edward W.; Phillips, Kenneth E.; Myers, Christopher W. (1981). Understanding cost growth and performance shortfalls in pioneer process plants. Rand. RAND Document R-2569-DOE. ISBN 0-8330-0352-6. http://health.rand.org/pubs/reports/2006/R2569.pdf.
Standish Group (2004) CHAOS Report. West Yarmouth, Massachusetts: Standish Group. (Report).
Westneat, Danny (2009). Tunnel’s cost may fool us all. Seattle Times (Seattle: Seattle Times). Available at: http://seattletimes.nwsource.com/html/dannywestneat/ 2009123442danny26. html. Retrieved on October 16, 2016.
