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

Under a cost-reimbursable-type arrangement, the suppliers will be reimbursed each month for their actual costs incurred on the project, subject to the terms of their agreement. Payments of fees are normally withheld until specific deliverable objectives have been met. But all incurred costs (without fee) are submitted by the supplier to the owner, and are then paid by the owner. Sometimes on cost-type arrangements, where the process is not watched closely there can be a wide disparity between the physical work done and the dollars spent. Thus, the risks to the owner escalate. We offer four recommendations to mitigate the risks with cost-type contracts. All owners on cost-reimbursable-type contracts should:

RECOMMENDATION No. 1

Require that the performing supplier (the designer or constructor) provide a time-phased "Schedule of Values" in which the sum of the line items will add up to the total contract value. A time-phased Schedule of Values provides the owner with a simple form of Planned Value against which performance throughout the life of the project may be monitored and measured.

RECOMMENDATION No. 2

Each month, as the suppliers submit their invoices reflecting the actual costs incurred, require that all contractors update their Schedule of Values reflecting a percent complete position, i.e., the Earned Value for the project. Thus, the owner of the project will have the means to monitor performance by comparing the Earned Value less the Planned Value to determine schedule variance, and also Earned Value less Actual Costs to determine the cost variance.

RECOMMENDATION No.3

Always monitor performance of both the cumulative SPI and CPI to compare results of one project to all other projects in the enterprise.

RECOMMENDATION No. 4

Continuously forecast the likely final costs on the project using a simple but accurate estimating technique (the total project budget divided by the cumulative CPI) to provide assurances that the project will be completed within acceptable cost risks to the owner. Unacceptable risks would be any forecasted final position that exceeds the owner's available funds, or penetrates the Guaranteed Maximum Price.

Fixed-Price-Type or Lump-Sum Contracts

Under a fixed-price-type arrangement, the suppliers are typically given progress payments based on their demonstrated percentage of work completed, together with the authorized budget for the completed work. Again--pure and simple--this is Earned Value at its finest, as typically employed on most construction projects. One can easily establish the Earned Value baseline or Planned Value using one of two methods: "Schedule of Values" or "Critical Path Method (CPM) Schedule."

SCHEDULE OF VALUES

Just as we recommended for cost-type work, the Earned Value baseline, or Planned Value can be created with use of a Schedule of Values," which is time-phased. The Schedule of Values can be updated monthly to reflect the measured Earned Value and used to authorize payments to the constructor.

CRITICAL PATH METHOD (CPM) SCHEDULE