Earned Value management: mitigating the risks associated with construction projects - Risk Management - Brief Article

Program Manager, March, 2002 by Quentin W. Fleming, Joel M. Koppelman

Everyone knows certain "truths" about Earned Value management. Such knowledge is often based what we may have heard others say about the technique. For example:

"Earned Value is useful only on large government-funded contracts." "Earned Value is useful only on cost-reimbursable type projects.". "Earned Value has no utility in the management of lump-sum or firm fixed-price work." "Earned Value does nothing for construction projects."

Respectfully, we take exception to these "truths" and would like to present a case for the employment of a simple form of Earned Value on all projects--large or small, cost-type and fixed-price--it really doesn't matter. The basic utility of Earned Value is to contain the cost risks associated with projects. Bad news never gets better with time. The earlier you know that you have a problem on your project, the better chance you will have to mitigate that problem.

While we believe you can, and perhaps should employ some minimal form of Earned Value on any project, as a way of facilitating this discussion we will cover using Earned Value on a specific type of project--a construction project. We will discuss the use of Earned Value on construction projects while employing either the Design-Bid-Build concept, or the Design-Build approach. Surprisingly, much of the basic Earned Value data is already available on most construction jobs. We will also make six specific recommendations for using Earned Value management to mitigate project risks.

What is Earned Value Management?

An interesting phenomenon exists in the construction industry. The industry probably uses parts of Earned Value management about as well as any industry. But, what makes it interesting is that in construction work, practitioners rarely use the term "Earned Value." Often, they do not even realize that they are in fact using a form of Earned Value. Anytime the construction cost engineers put a project baseline plan in place, this is Earned Value in its purest form. But ask cost engineers if they use Earned Value management and often you will get a blank stare.

A typical project baseline plan would consist of: 1) a detailed schedule containing all of the authorized work; 2) schedules containing the authorized resources to conduct the work; and 3) payments by the cost engineer to contractors based on their physical accomplished work, together with the original authorized budget for the work.

Earned Value management is a technique that can be applied, at least in part, to the management of all capital projects, in any industry, while employing any contracting approach. The employment of Earned Value requires a three-dimensional measurement of project performance, ideally from as early as possible--perhaps as early as 15 percent complete, up to 100 percent final completion. However, two of the three dimensions of Earned Value--the baseline plan and the physical performance measurement--will apply to all capital projects, in any industry using any contracting method.

Point: People sometimes get "hung up" on precise terminology. The ardent proponents of Earned Value will often use specific terms with exact meanings. Most construction managers may not use the Earned Value terms "Planned Value" or even "Earned Value," but the process they go through to establish their baseline plans and then to measure performance against their plans is exactly the same. Only the jargon may be different.

To understand the concept, we must understand the following three dimensions of Earned Value:

* Planned Value, which consists of the authorized work, along with the authorized budget, within the authorized time-frame, which in total forms the project baseline.

* Earned Value, which is the authorized work that has been completed, plus the original budget for the work.

* Actual Costs, which are the actual costs incurred to convert the Planned Value into the Earned Value.

Both the Planned Value and the Earned Value dimensions will apply to all construction projects. Only Actual Costs are sometimes unknown in construction, particularly on fixed-price or lump-sum jobs. In the discussion covering progress payments later in this article, we offer a few recommendations to help better manage the process.

What is the Design-Bid-Build Concept (or Engineer-Procure-Construct Method)?

The more traditional, established approach to construction is called the Design-Bid-Build concept, or, sometimes also referred to as the Engineer-Procure-Construct method. This approach takes a new construction project and breaks it into three distinctive but sequential phases:

* The complete design of the new item.

* The execution of a competitive solicitation, bidding, and construction contract award process.

* The actual construction of the new facility

Today, construction work is most likely accomplished under the Design-Bid-Build approach.

To start Design-Bid-Build, a selection is made of an architectural or design firm to capture the thoughts of the owner of the new project. Because this broad conceptual direction is often subject to changes as the design solidifies, such work is often (but not always) done on a soft or cost-reimbursable contract basis. The owners often start out by describing what they envision as a final product, but will often change directions to the architect as the design evolves. The design firm, taking directions from the owner, then completes the definition up to what is described as the 100 percent complete design point.