There are plenty of reasons why companies start a project. Numerous divisions in medium-to-large organizations are constantly engaged on many different projects at the same time. The PMO (Project Management Office) oversees the commencement, execution, and effective completion of projects within a business. Even so, project budget overruns are an unavoidable reality in any business.
This blog will cover 3 real life cost overruns you can encounter in your projects, the most common causes that lead to cost overruns, many ways you can prevent them, manage and stop them completely, and the role Project Management Officers play when it comes to project success.
How Common Are Project Budget Overruns?
Let’s get some background on project cost overruns before we get into the details of why it happens and how to prevent them.
The budgets and predicted performance advantages of almost 1,500 projects were compared to the actual expenditures and outcomes by the HBR and the standard overrun was of 27%, but that statistic belies a considerably more frightening reality. One out of every six projects reviewed by the Harvard Business Review turned out to be a “black swan”, with an average budget overrun of over 200%, along with a schedule overrun that was roughly 70%.
Schedule setbacks, incompetent personnel, and project budget overruns were the most prevalent challenges for project delivery companies, according to some polls.
You might be wondering: if project budget overruns are such a regular problem in the project management industry, why have we not figured out the causes? And if we do know the causes, what can we do to avoid them? If there’s no way to avoid them, then is it possible to at least manage them? Keep reading to learn the answers to those questions!
A Project Cost Overrun Example
Let’s go through some examples of project cost overruns caused by different things that you could see in your real life.
1st Case: An unfulfillable solution is sold by a sales manager.
Result: The team has to work on implementing the new features, causing a cost overrun of 1%.
2nd Case: The supplier team’s premise entry documents are not approved on time by HR.
Result: The supplier gains entry to the premises delayed, costing the company thousands of dollars.
3rd Case: A couple of days after an important deadline, the accounting department finally authorizes the budget for the project.
Result: The resources given for the project sit idle for days, costing the firm thousands of dollars.
According to a Project Management Institute study, project management expertise among business personnel can boost project completion on schedule by 49%, and project completion on budget by 40%.
Why Do Project Cost Overruns Happen?
There might be various reasons for why a project might overrun its budget; however, imprecise scope definition, inaccurate estimates, unforeseen risks, and incompetent personnel aremost typical explanations. We’ll go through each of these factors in greater depth further down.
Causes For Project Cost Overruns #1– Ambiguous Or Undefined Project Scope
When your project’s scope is unclear, ambiguous, or misleading it is certain to generate problems. The project’s team members will carry out the tasks that they believe they have grasped from within the project scope. Frequently, resources will end up making assumptions that may turn out to be incorrect in the end, and this can result in some terrible misunderstandings. Whether it was poorly specified or conveyed in the scope, or just misunderstood, the project will have unfavorable effects. As a result, there may be a need for repairs or rework, resulting in project budget overruns.
Causes For Project Cost Overruns #2 – Nonessential Activity Assessment
In this undertaking, accurate estimations are critical. Estimating the length of an activity, as well as the number of resources necessary, are just some examples of things which are frequently estimated wrong. Let’s imagine you were given three resources to complete an activity, but that activity might have been completed by two. As a result, you’ll be paying for one extra, useless resource. Alternatively, if a task that could be completed in five days was extended to eight days. This will also turn out to be more expensive.
Causes For Project Cost Overruns #3 – Unexpected Risks
Project difficulties and budget overruns are frequently caused by the absence or inefficient risk management. Materials, employees, equipment, cost, suppliers, and other factors might all contribute to project problems.
Organizations frequently establish risk management procedures in place. Nevertheless, the personnel assigned to risk management operations might be inept. This might lead to hazards being overlooked, inadequately planned, and ineffectively handled. If those risks arise, the expense of controlling them will be higher. If organizations have no strategy or budget already in place to address risks that were not foreseen during the project planning stage, their project will inevitably lose time and money.
Causes For Project Cost Overruns #4 – Inept Resources
Something, it can be less expensive to assign a lower-skilled resource to a task. But there will be hurdles to overcome if that same resource keeps making mistakes or taking way longer to perform a task.
For example, if a task is expected to be done in 5 days and costs $20,000 to complete, using an inept resource might end up costing you $5,000 extra. Project resource management can be an art. Neither overqualified nor unskilled resources should be recruited. Overeducated resources will raise costs, whereas inept resources will also raise costs.
How to Stop Project Budget Overruns
Every budget overrun may not appear to be big, however, if each project overspends by 2 percent or more, you will feel it once it builds up and reaches a significant amount. If this happens by the year end, it might also affect any bonuses or rewards people could have otherwise gotten. Some staff members look forward to that the whole year, and project cost overruns can make it go away if you’re not careful.
Unfortunately, going over the budget became the standard over the years for most projects. Ideally, reality needs to be quite different. Luckily for project managers, project budget overruns may be avoided with solid and detailed planning, as well as a lot of effective tracking, and supporting stakeholders. Here are some of the best techniques you can use to avoid project cost overruns.
Things To Do To Prevent Project Cost Overruns #1 – Stop Scope Creep
Scope creep refers to the inclusion of new features to a product, or set of requirements that would be considered outside of the agreed scope. Any project can experience scope creep. It can also lead to budget overruns, scheduling delays, and lower customer satisfaction. It’s not a terrible idea to introduce a new feature that produces good outcomes, however, if it’s not accepted, scope creep will occur, which must be avoided.
Scope creep can happen for a number of reasons, including vagueness on what is actually needed, a customer attempting to get additional work done cheaply or free, beginning progress of something without proper planning, little or no customer relations with the development team, an absence of change control, varying stakeholder viewpoints, and a poor schedule or cost estimate.
Scope Creep can be easy to combat. You just need to clearly set requirements that correspond to the demands, expectations, and desires of the consumer. When this is completed, it is critical that the team has a clear knowledge of the things that are actually required. This is a critical stage because the team is going to build and deliver the desired product according to this information.
Basically, project managers need to communicate with the client to understand each need. When the team is unsure, they should explain the project’s scope again to try to clarify it. The team must adhere to the specifications, and if they have any doubts, they must seek clarification from the scope or the lead project manager. Furthermore, there should be no nepotism, favoritism, or bias in the initiatives. Any changes that are made have to be authorized, then included in the product.
Things To Do To Prevent Project Cost Overruns #2 – Gather Up Skilled Resources
Once you have a good understanding of the customer’s project needs and specifications, you should hire people with the necessary expertise. You could assume you’re getting a good deal if you appoint a rookie resource to an activity that needs a veteran resource. In actuality, the task might take longer to finish and cost more than you anticipated.
You should select resources with the necessary talents and also the necessary amount of experience. Why should you do that? Simply because a lower-skilled resource could misinterpret the requirements. Alternatively, they might be incapable of generating anything exactly as planned. It’s also possible that they could be doing everything correctly, but they are moving way too slowly. These factors may cause your project to be delayed or necessitate the reworking of some tasks. As a result, project budget overruns will occur.
If your preparation is flawless and your paperwork is meticulous, but the resources are insufficiently skilled, you will run into problems. And we all know that dealing with problems comes at a price. You must only recruit resources that can prove to you that they are capable of working on the project at hand. According to IBM’s training study, every dollar invested in corporate courses and training programs can give you $30 back. So, keeping that in mind, corporate firms place high importance on training their staff in order to improve project delivery competency.
Things To Do To Prevent Project Cost Overruns #3 – Adequate Risk Management
Risk management is critical to maintaining the project on track and on budget. Extra expenditures required to resolve risks will create project budget overruns if those risks aren’t effectively recognized, or if the appropriate contingency reserve isn’t really established for those risks.
As a result of the lack of adequate risk management, some hazards may arise unexpectedly. And you’ll be completely unprepared to cope with them. At that point, you’ll strive to make use of your assets to mitigate the dangers’ implications. However, a quick response towards the risks would require the deployment of resources not included in the project’s budget. You might not have any alternatives for dealing with an unexpected dangerous occurrence. Therefore, you’ll wind up doing everything it takes to control the risks as rapidly as possible, which might end up costing you much more money.
Project managers need to make a concerted effort to examine all conceivable outcomes. To do so, they should draw on their previous expertise, past data, and brainstorm thoroughly to find the risks. Any complications and risks should be identified during the project, though doing it early is far preferable. After the risks are identified, they should all be evaluated independently for their likelihood, effect, and importance. Risks can also be divided into categories.
An appropriate way to do so might be depending on security, technical, economic, internal, resources, external, or other factors. Categorization assists project managers in determining where the greatest amount of uncertainty exists. It also aids in the reporting and monitoring of data. Every risk requires calculating and storing the proper quantity of reserves.
Things To Do To Prevent Project Cost Overruns #4 – Avoid Untrained People
Always remember it is people — not just your project’s plan, work practices, or other factors — who can be responsible for having to deal with project budget overruns. Typically, project managers concentrate on project documents, activities, and all the resources required to finish the project. But they should consider that untrained project personnel, who lack basic project management skills and experience, might be a roadblock to success.
Jobs completed by inexperienced resources can exacerbate the problem since they are unaware of the procedures that need to take place. Furthermore, because there is no one that’s in charge of them from the top down, they won’t function according to a set of rules. Hence, unskilled resources may generate inefficiencies in their work, deliver with mistakes, or make poor judgments. Untrained employees may have a minor negative influence, but they might be devastating for the overall project. Problems produced by inexperienced individuals may need a lot of repairs or complete rework. As a result, project budget overruns would occur.
How to Control Project Budget Overruns
Nobody wants their project to go over budget. However, if this occurs, there are various options that you can apply to overcome these challenges and effectively manage the cost overruns. Let’s continue by talking about all of the ways you can control project budget overruns.
Ways To Manage Project Cost Overruns #1 – Add The Project Budget Overruns Into Your Project Manager Limits
The degree of Project Manager authority in each organization is varied. Some costs and schedule delay constraints can be managed by a Project Manager to mitigate overruns in particular instances. A Project Manager, for example, could be permitted to oversee a project that has a budget variance of +5%, and a schedule delay of +7%.
However, nobody should use this to their advantage. Even when a limit exists for the project cost overrun, Project Managers should make every effort to stay within the budget. Following the budget will not only save the company money but also lowers waste. If the budget overruns are out of control for whatever reason, the Project Manager should respond quickly. They should make every effort to keep the budget overruns within some acceptable bounds.
In the event of cost overruns, it is the Project Manager’s responsibility to deal with the matter. They should consider the numerous options and the project priorities in order to keep costs under control. They must also speak with the major stakeholders in the project in order to come up with a mutually beneficial solution.
The budget baseline acts as a benchmark against which cost performance may be measured and controlled. To check for cost variation, the Project Manager should maintain a steady watch on the baseline and the real cost. They can accomplish it by applying a variety of cost estimation techniques like looking into the cost S-curve, for example, or the cost histogram.
Ways To Manage Project Cost Overruns #2 – Evaluate Make & Buy Options
Make and buy both have some pros and some cons. At operational as well as strategic levels, make and buy examinations are carried out. Whether to purchase or make is determined by a variety of circumstances. Ideally, organizations select the most appropriate solution for every project.
There is no need to be concerned about your skills or the manufacturing process while purchasing. Since manufacturing the product yourself allows you to have more control over it, you may make it as unique as you want. There’s also no need to set up and follow any established terms and conditions. For both choices, the price can be a common component. Project managers need to weigh the pros and cons of both making and buying, as well as other aspects, before deciding how to proceed.
In some circumstances, purchasing rather than manufacturing may be more cost-effective, because you won’t have to invest money in the resources and infrastructure required to complete the task.
The Project Manager should evaluate the requirements, available money, timeline, and other restrictions for each choice. Following that, the Project Manager can determine whether particular work packages should be outsourced so they can be completed at a cheaper cost.
Ways To Manage Project Cost Overruns #3 – Create A Contingency Reserve That Will Soften The Overrun Impacts
The sooner you accept that no project goes exactly as planned, the earlier you will be able to prepare for it. There are several elements that contribute to the desire to overspend. While sometimes it may be necessary to overspend, doing so will result in project budget overruns and will have a bad influence on the project’s image.
As a result, there has to be contingency buffers already planned within the project in case of unanticipated circumstances. The reserves might be maintained at the activity level, work package, or overall project. Because reserves will be included in the agreed budget, using them in a specific scenario would not jeopardize the project. Therefore, project managers must calculate the amount assigned for contingency reserves in case of an unexpected setback. This can be accomplished with the assistance of competent risk management.
Assumptions shouldn’t be used to generate contingency reserves. Instead, you should use a variety of risk management strategies to calculate it. By using tools like the risk register, as well as the Expected Monetary Value technique, project managers can have complete control and power over this reserve. Picking how much to use out of the reserve and which activities need it when the time comes is up to the Project Manager.
Since contingency reserves are often smaller at the conclusion of a project and bigger near the start, Project Managers may also track the usage of contingency reserves with the passing of time and try to manage them to reach the best possible conclusion by using charts and graphs.
You may utilize the data from the contingency reserve to convey the risks for the project to the stakeholders, in order to protect against project budget overruns. So, a contingency reserve can be a very important risk management tool that will protect your project from cost overruns. It should also be a component of any project’s planning.
Ways To Manage Project Cost Overruns #4 – Talk To Your Seniors
It is prudent to apply the designated contingency reserve in case the project starts to encounter cost overruns. But what happens if the budget overruns exceed your budgeted amount? You would have no contingency reserve left in this circumstance. In this scenario, don’t wait to speak with your superiors; take action right now. If you want to overcome risks that end up being worth more than the assigned contingency reserve, the organization needs to establish another reserve, called the management reserve.
The management reserve has been frequently calculated as a percent of the total project budget. The amount assigned to the management reserve required may vary depending on what type of project you’re working on. It can also depend on how you want to handle the project budget overruns. In many cases, the reserve for research projects is bigger, while the reserve for product development can be smaller. Project managers, on the other hand, can consider different options for determining each management reserve. They should examine the results of similar previous initiatives to identify an adequate management reserve.
What We Learned About Project Cost Overruns
It’s not uncommon to have a project go over budget. Cost overruns will happen to any project, be it a building project, an IT project, a medical project, or anything else. Budget overruns can occur on any project, although larger or sophisticated projects are especially prone to them. However, factors outside our control may have an influence on the cost of the project. Things like inflation, extreme weather, and other factors can all have a role, but most times you can be sure there are plenty of other factors at play. Budget overruns are typically caused by insufficient analysis, not enough planning, and inaccurate estimation, among other issues.
We discussed some very prevalent causes of project budget overruns in this blog. We also discussed how to avoid and deal with overruns. Risk management can be one of the aspects linked with budget overruns that businesses should not overlook. Some dangers have the potential to knock companies to the floor. Many high deviations might lead to unfavorable outcomes like project cancellation or postponement, reduction of project scope, and customer trust loss.
Among the most effective methods for managing project budget overruns is to plan and use project contingencies, as well as the management reserves. Rather than allowing project expenditures to go over the budget, it’s much preferable and appropriate to employ reserves to continue being under budget.
Understanding the information in this article is an essential part of project management and a vital part of the PMP exam. Improve your project management skills or prepare for the PMP Certification exam by taking a quality online PMP exam prep course.