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 underestimation of the actual cost during
budgeting. Cost overrun should be distinguished from cost escalation, which is used to
express an anticipatedgrowth 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. Overruns of 50 to one hundred percent were common. Cost
underestimation was found in each of 20 nations and five continents covered by
the study, and cost underestimation had not decreased in the 70 years for which
data were available.For IT projects, an industry study
by the Standish Group found that the average cost overrun was 43 percent; 71
percent of projects were over budget, exceeded time estimates, and had
estimated too narrow a scope; and total waste was
estimated at $55 billion per year in the US alone.
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.The Sydney Opera House cost 15 times
more than was originally projected, and the Concorde supersonic
aeroplane cost 12 times more than predicted.When Boston's "Big Dig" tunnel
construction project was completed, the project was 275 percent ($11 billion)
over budget.The Channel Tunnel between the UK
and France had a construction cost overrun of 80 percent, and a
140-percent financing cost
overrun
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 aratio 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.