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

Another very effective method to establish an Earned Value baseline would be to require that the performing supplier create and submit a "Critical Path Method (CPM) Schedule" with resources embedded into the CPM network--the sum of which must add up to 100 percent of the contract value. Assuming that your schedule software package has the ability to freeze this baseline, you will have in place the equivalent of a Planned Value baseline. Payments to suppliers will be made each month based on their reflected percentage completion--their Earned Value. (Note that the resource-loaded CPM schedule will work nicely on either cost-type or fixed-price work.)

Typically missing with fixed-price or lump-sum work, however, are the Actual Costs related to the Earned Value being measured. Without the Actual Costs related to the Earned Value achieved, we lack the ability to determine the cost performance efficiency factors--the CPIs--which are likely the most important metric in Earned Value management. However, there may be a way to get the information needed to bring owner risks down to acceptable levels, without invading the sacred cost ledgers of our performing fixed-price suppliers.

Whenever performing suppliers accept a fixed-price job, they are often highly reluctant (they adamantly refuse) to disclose to the owner how much profit they are making on a given job.

Question: Do we really care if our suppliers make a profit on our jobs, even a big profit? We don't think so.

It's only when suppliers start incurring a loss, particularly a big loss, that we should really be concerned. The bigger the loss, the more likelihood the supplier may not complete the job. To mitigate risks to the owners, we need to know about, and to quantify potential supplier losses as early as possible.

RECOMMENDATION No. 5

Require that all fixed-price suppliers provide a financial projection of their anticipated costs incurred, to accompany their Planned Value projections contained within either the time-phased Schedule of Values or their resource-loaded CPM networks. Such costs-incurred forecasts should typically resemble what is commonly called an "S" shaped curve, or sometimes referred to as "one-half a bell shaped curve." Such financial curves typically will project a slow beginning, a fast acceleration in the middle, and then a slow close-down to completion. Unless extenuating circumstances exist, all project expenditure profiles should resemble an "S" shaped curve. Anything other than an "S" curve might indicate that the cost projections may be front-loaded. Always watch out for front-loaded project baselines.

RECOMMENDATION No. 6

As a condition to making monthly payments to fixed-price suppliers, require also that the Chief Financial Officer (CEOs) for your suppliers "certify" each month that they have not exceeded their own financial forecast of costs incurred. However, if they have exceeded their own forecasted values, require that they also disclose the amount of their costs incurred, so that you can compare it to the Earned Value and quickly determine the amount of loss the contractors are experiencing.