Cost Overrun - Causes

Causes

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. Scope creep, where the requirements or targets rises during the project, is common. 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 and Martin Wachs of University of California, Los Angeles have shown that big public-works projects often have cost overruns due to strategic misrepresentation—"that is, lying", as Flyvbjerg 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 was $100 million, and the actual cost was $150 million, then the cost overrun may be expressed by the ratio 1.5, or as 50 percent.

Reference class forecasting was developed by Flyvbjerg to eliminate or reduce cost overruns and benefit shortfalls. Daniel Kahneman, Nobel Prize winner in economics, calls Flyvbjerg's counsel to use reference class forecasting to de-bias estimates of costs and benefits, "the single most important piece of advice regarding how to increase accuracy in forecasting.”