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

For example, if we take the Earned Value achieved and divide it by the Planned Value, we determine the schedule efficiency factor, which we call the Schedule Performance Index (SPI). Any SPI value less than 1.0 indicates that we are running behind with our planned schedule. If our SPI is .84, this condition indicates that for every dollar of work we planned to do, we only did 84 cents of work. The SPI provides a quantified metric.

Most important, however, is the cost efficiency we are achieving. Cost overruns are more serious than falling behind our planned schedule, only because in the end the schedule will eventually be recovered, whereas the cost overruns are rarely (if ever) fully recovered.

We determine our cost efficiency rate--the Cost Performance Index (CPI)--by dividing the Earned Value by Actual Costs incurred. Any resulting value less than 1.0 indicates that we are overrunning our costs. For example, a CPI of .82 indicates that for every dollar we incurred in expenses, we only accomplished 82 cents of value. Thus, we are overrunning our costs.

The significance of the CPI metric is empirically proven (with over 700 DoD projects studied) to stabilize at the 20 percent completion point of a project. Also, the CPI metric becomes progressively more stable as the project continues toward the 100 percent completion point. Thus, the CPI can be used to forecast the final project costs from as early as 20 percent into the project. To forecast total final costs, the total authorized project budget (Budget at Completion) is divided by the cumulative CPI. Thus, you can continually monitor and forecast the final required costs to complete your project. It is as simple as that.

Using Earned Value to Make Progress Payments on Construction Projects

Owners of all projects (including construction projects) must take care to never place themselves in a position of overpaying their suppliers for the work they complete. Stated another way, the very quickest way to increase the risks on any project is to overpay suppliers for their completed work. Cost-type arrangements have inherent risks because some owners simply focus on the actual expenses incurred, without also closely monitoring the actual work accomplished for the monies spent. Earned Value management can help in this process.

Likely, the best way to mitigate construction risks on fixed-price or lump-sum work is to accurately measure the value of the work completed, together with the original budget authorized for the completed work, and then only pay for the actual work accomplished, less any withholds or retentions as may be allowed by the contract. Earned Value management can also help with this process.

Payments on "Cost-Type" and "Fixed-Price-Type" Contracts

Today, the two broad contractual environments prevalent throughout DoD are cost-type and fixed-price-type. Both need to be addressed separately-both represent separate issues.

Cost-Type Contracts

Cost-type contracts are sometimes (perhaps often) used in construction projects to cover the initial design work--both the preliminary and final design--in both Design-Bid-Build and Design-Build approaches. Additionally, on selected other projects that are considered to be inherently high risk for the constructor (for example, nuclear energy construction), cost-type contracts are sometimes used for all phases--both the design work and the construction effort.