BASIC CONCEPTS

The contents of these articles build on assumed knowledge relating to general risk management and schedule risk analysis. It is recommended that readers first familiarise themselves with the associated knowledgebase content pages relating to risk management principles and schedule risk practices before continuing.

3.1 BASIC CONCEPTS

3.1.1 WHAT IS INTEGRATED COST & SCHEDULE RISK ANALYSIS?

Integrated Cost & Schedule Risk Analysis (IRA) is a quantitative Monte Carlo analysis technique for assessing probabilistic cost and schedule outcomes. Unlike traditional separate cost and schedule risk analysis techniques, in IRA, the cost risk analysis is directly incorporated with the schedule risk analysis, such that both elements are analysed concurrently in a single model. Costs are divided into time independent (eg. materials) and time dependent (eg. labour), then allocated to the schedule tasks to which they relate. During analysis, as task remaining durations change, so too do the calculated values of the time dependent cost components.

Using IRA, we can gain many valuable insights into a project and its probabilistic behaviours. These insights include, but are not limited to:
• How likely is it that the deterministic schedule and estimate will be achieved?

• What are appropriate levels of cost and time contingency in order to be x% confident of achieving project objectives within budgeted allowances?

• Which risks / uncertainties are the biggest determinants of project cost and schedule outcomes?

• What is the likely time and/or cost consequence of failing to adequately treat a known risk?

• Which execution option will likely result in the optimum balance between performance on cost and schedule objectives?

3.1.2 THE EVOLUTION OF THE IRA METHODOLOGY

Estimators and cost controllers have traditionally come from the ranks of quantity surveyors and cost engineers, while project planners and schedulers have tended to emerge from the ranks of design and construction engineers. The first group is concerned with counting and quantities while the second group is more concerned with how things are put together.

This has carried through to the application of Monte Carlo simulation: Cost Risk Analysis (CRA) tends to be performed by practitioners with estimating or cost control backgrounds, using spreadsheet based tools like @Risk and Crystal Ball. Conversely, project planners who have transitioned into schedule risk analysis (SRA) tend to use Monte Carlo simulation tools built on project planning software such as Primavera Risk Analysis (formerly Pertmaster).

Before the widespread adoption of the IRA approach, where separate cost and schedule risk analyses had been conducted, the outputs of a SRA would be fed into a CRA as a schedule risk allowance using an assumed cost ‘burn rate’ over the contingency period.

There are three clear issues with this approach which we will identify as the ‘when’, ‘where’, and ‘why’ of how traditional approaches to combining cost and schedule risk fail to accurately characterise the true project uncertainty. To demonstrate this point, consider the following scenario:

"A schedule risk analysis reveals that an additional 30 days of contingency are required to the planned duration to be 90% confident of achieving project completion on time. It also reveals that the bulk of the duration uncertainty for the project is distributed across its construction phase. The results of the schedule risk analysis are then input to the cost risk analysis at an assumed cash burn rate of $1 million dollars a day based on the conservative assumption of peak construction manning levels."

When: The first issue relating to the combining of separate cost and schedule risk analyses lies in the assumed cash burn rate per day. For the example above, because the bulk of the duration uncertainty was identified as coming from the construction phase, the assumed cash burn rate per day was calculated based on peak construction manning levels. However, this assumption is overly pessimistic, as only a proportion of the construction period will actually run at peak manning levels. What if delay occurred before all contractors had been mobilized to site? The capital cost impact of the delay would understandably be significantly reduced. Similarly, critical path delays affecting pre-execution engineering or approvals would have drastically different cost impact profiles. The calculated cost of delay is clearly dependent on when the delay occurs.

Where: The second issue relates to where in the program a delay occurs. It is likely that the schedule will consist of multiple parallel paths of tasks that ultimately converge on one completion milestone (either directly or through other connected tasks). Some of these paths will be dominant in determining the completion date of the project, occurring frequently on the critical path, whereas others will not. It is entirely possible for a chain of tasks to be significantly delayed, but never impact on the overall project critical path. However, even though they’re not impacting on the end date of the project, prolongation costs will still be incurred associated with the delays, due to longer use of hired equipment, labour, etc. Calculating the cost of a schedule allowance based on delay to project completion fails to account for these non-critical delay cost uncertainties.

Why: The final issue with the traditional approach to cost and schedule risk analysis deals with why a particular answer was given, what was driving it, and the assumptions and methodology of how it was derived. Separate cost and schedule risk analyses will almost always have different assumptions that underlie their inputs. A cost risk analysis that draws from the result of a schedule risk analysis must take account of the schedule assumptions underlying the schedule answers to accurately portray forecast cost of delay over-runs. Further, because the schedule is analysed separately from cost, the visibility of individual schedule elements as drivers of delay cost is lost. We can indeed attribute a certain amount of cost contingency requirement to schedule, but why it is required, what drives it, and how it has been derived is very difficult to express through such a methodology.

3.1.3 WHY PERFORM INTEGRATED COST & SCHEDULE RISK ANALYSIS?

True IRA overcomes the limitations of traditional separate cost and schedule risk analyses by concurrently analysing both elements in a single integrated model. Continuing the example from 2.1.2 , we see that IRA has several advantages over the traditional approach:

When: Because costs are directly overlaid on the schedule tasks to which they relate, the cost impact of schedule change will be calculated accurately according to the cash ‘burn-rate’ specific to that phase or area of the project. For example, delays incurred prior to final investment decision, when no orders are placed & no construction contractors have mobilised will be calculated according to only the affected disciplines (eg. engineering & owner’s costs).

Where: Where in the program delay occurs is critical to calculating what the subsequent impact is. Should an engineering delay affect procurement or Approved for Construction documentation, it is entirely possible that this may cause subsequent delays and increased costs in construction. However, should a delay occur in engineering closeout, it is likely to affect prolongation costs for engineering only, with no impact on construction activities. Again, because IRA spans costs directly across the tasks to which they relate, it accounts for these complexities. In doing so, delays affecting tasks with no ‘knock-on’ effects will impact only the calculated cost of the affected task. However, should the schedule delay affect subsequent dependencies, these costs will be affected also.

Why: Apart from realistically calculating the cost impact of schedule change, IRA has the secondary benefit of being able to rank all drivers of project cost, including uncertainties that have only schedule impact. In doing so, IRA facilitates the creation of sensitivity tornado diagrams which identify the largest drivers of project cost uncertainty. Understanding these ranked drivers helps direct limited resources to perform targeted actions, producing the best economy in limiting risk exposure for minimal expended effort.

3.1.4 WHEN TO PERFORM INTEGRATED COST & SCHEDULE RISK ANALYSIS

Much as with Schedule Risk Analysis, IRA often gives the greatest benefit at the early stages of the project lifecycle, before many of the large decisions have been made and the project is committed on a course of action. As described in 2.1.3 , as a project develops, the opportunity for affecting change typically decreases, and the cost of doing so typically increases.

During the Concept Selection phase of project development, IRA can be used to model the outcomes of different development options, helping determine which option may result in the earliest schedule outcomes and/or minimal capital expenditure. The analysis may make use of different models to compare the various options, or alternately, it may make use of techniques such as probabilistic branching. However, IRA can only be used in situations where a representative schedule is available that is well aligned with the project estimate.

During Front End Engineering & Design, IRA can be used to determine appropriate levels of cost and schedule contingency prior to Final Investment Decision. Understanding the range of potential cost and schedule outcomes before committing large amounts of money forearms stakeholders with the information necessary to understand their risk exposure and whether the project represents an economically viable investment. During this phase, execution risks can also be examined, and targeted actions put in place to avoid, transfer, or reduce exposure to them.

During the Execution Phase, IRA can be used for project re-forecasting and to assess emergent trends. As the project progresses, the risk profile changes, with exposure to some risks expiring, and some risks eventuating. New risks may also be identified, or assessment of existing risk ratings may change as more information becomes available. Performing IRAs in execution also helps to give a ‘health-check’ of the project schedule and estimate, ensuring that the documents stay representative of what’s happening and aligned with one other. Another key benefit of performing IRA during execution is the quantification of required remaining contingency in both cost and time, enabling re-assessment of contingency draw-down and the adequacy of previous contingency provisions.

3.1.5 COMMON SOURCES OF COST UNCERTAINTY

In section 2.1.4 , we discussed in detail the common sources of schedule uncertainty, including quantity uncertainty, productivity uncertainty, staffing uncertainty, schedule risk events, and weather uncertainty. However, most of these are not uniquely schedule related, but usually drivers of cost also:

• Additional materials / equipment quantities require more time to install, but will also cause additional purchase and installation costs.

• Lower productivity levels result not only in schedule delays, but increased labour costs associated with prolongation also.

• Increased staffing numbers may result in a faster schedule, but at the price of increased unit per time costs.

• Schedule risk events have the potential to delay project completion, with the potential to impose significant project prolongation costs. Even risk events that occur off the critical path can still affect the cost of at least a portion of the project budget.

• Under many contracts, downtime associated with inclement weather will cause additional costs to the project. Even though no work may be getting done at site, someone usually still has to pay the workers!

As can be seen, there’s a great deal of relatedness between schedule and cost uncertainty, and this is where the IRA methodology stands out above more traditional risk analysis techniques in terms of realistic modelling of project costs. By applying time dependent costs to the tasks to which they relate, we’re able to accurately assess the cost consequences of schedule changes, be they from productivity delays, inclement weather, schedule risk events, or any of the other sources of schedule uncertainty

Of course, in addition to those factors mentioned above, there are some cost risk factors that are completely unrelated to schedule when assessing the potential capital cost of projects. We will mention a few prominent ones here:

• Labour rate uncertainty: This refers to the rate per unit time at which members of the labour force will be paid. There are usually two main constituents here – 1) uncertainty regarding negotiated labour rates in an enterprise bargaining agreement, and 2) uncertainty regarding the seniority of personnel with which the project will be staffed.
• Material / Equipment Price Uncertainty: Unless material and equipment orders have already been placed, there is usually uncertainty over how much they will cost to procure and deliver to site. This is usually driven by market factors such as raw material costs and market demand for the commodity in question. However, project factors such as geographical remoteness can also contribute to delivery cost uncertainties. For some equipment, even after order placement, there is often still residual cost uncertainty regarding the requirement for time of vendor representatives at site during installation / commissioning.
• Cost Risk Events: Some risk events will ultimately have significant cost impact, but little to no discernable schedule impact. For example, there may be a risk that labour force market conditions will be ‘hotter’ than expected, requiring that the project pay higher rates than expected in order to attract a sufficient quantity of quality personnel to the project. In IRA however, where a risk has both cost and schedule impacts, it is very important that prolongation costs be omitted as impacts of the risk. These costs are ultimately calculated through the risk’s schedule uncertainty acting on the time dependent costs in the model.
• Economic Factors: There are of course a multitude of economic factors that may affect the final capital costs of the project. However, perhaps one of the most commonly encountered ones is Exchange Rate Uncertainty. No project exists in a bubble, and unless exchange rates have been hedged, fluctuations in international market conditions will continue to present an exchange rate risk to any project involving exchanges in multiple currencies.

3.1.6 THE IMPORTANCE OF COMMERCIAL ARRANGEMENTS

We talked above about the relationship between time and cost. We provided the broad brush example that labour costs would typically be considered time dependent, and that material / equipment costs would be considered time independent. Therefore, should schedule changes occur, calculated labour costs would be affected, but material and equipment costs would not. However, it is important to note that the commercial arrangement or contracts between parties have the potential to change the way in which costs are treated as time dependent or time independent within an IRA model.

Should a contract contain conditions that assert that the primary contractor assumes responsibility for inclement weather, it is then not appropriate when calculating Owner’s cost contingency to include any allowances for inclement weather. In such an instance, it would not be appropriate to use time dependent costs on any tasks affected by probabilistic weather downtime calendars, as this would artificially introduce cost pessimism into the calculated Owner’s cost contingency requirement.

However, even though weather risk may have been allocated contractually to the contractor, it may be prudent to include a risk event that extreme weather or a weather event may exceed the limits of the Contractor’s contractual or insurable capacity to absorb weather risk, necessitating further impact to be absorbed by the Owner. The risk assessment process should carefully determine the probability and impact ranges in time and cost from such a risk.

Lump sum contracts are a good example of how a commercial arrangement can influence whether delay costs should born by the Contractor or the Owner. Usually the Contractor cannot exceed insurable limits which may be defined in the contract or, in situations where disputes go to arbitration or even to court, case law and precedents may become relevant.

So whether costs are treated as time dependent or time-independent may depend on the Contract Terms & Conditions, but there are usually limits to this, which may need to be considered in an IRA process and which may justify the addition of risk events corresponding to exceeding the limits.

This is a very large subject beyond the scope of this Knowledge Base. We refer readers to AACE International’s excellent Recommended Practice RP 67-11 “Contract risk allocation – as applied in engineering, procurement, and construction”, which is freely downloadable from AACE International’s website – AACE International’s website .