What policies can reduce or prevent cost overruns on big infrastructure projects?

Question

Big infrastructure projects often lead to major cost overruns. For example:

• Betuweroute railway in The Netherlands, planned at 2.5 billion €, final costs 4.7 billion €
• Gotthard base tunnel, estimated at 8 billion Swiss francs, present estimate 12 billion Swiss francs
• Amsterdam Noord/Zuid-lijn, estimated at 300 million euro, present estimate 900 million euro

What causes such big cost overruns (that are almost always associated with delays as well) and what can be done by decision-takers to prevent them?

Answer 1

There are three main reasons for such big cost overruns:

1. People are generally sucky at estimates of time or money. I'm intimately familiar with that from software engineering project management side, but most of the issues aren't specific to programming. Anyone thinking X will take N days and M dollars should budget 3X days and 4X dollars.

2. If you are trying to sell a large project politically (meaning, seem like you care about taxpayer money), citing realistic correct costs is a sure way to NOT have your project approved, since - as you can see from the example of Big Dig, the difference is usually "this will get paid off in 3-5 years in benefits" vs "This will get paid off in 50 years, if at all". This means that people are strongly incentivized to underestimate the costs dramatically and NOT try to get real ones. It's not THEIR money being spent, after all.

   For those who don't know: Big Dig in Boston was a humongous infrastructure project famous for overruns.

   "The project was scheduled to be completed in 1998 at an estimated cost of $2.8 billion (in 1982 dollars, US$6.0 billion adjusted for inflation as of 2006). The project was not completed, however, until December 2007, at a cost of over $14.6 billion ($8.08 billion in 1982 dollars) as of 2006. The Boston Globe estimated that the project will ultimately cost $22 billion, including interest, and that it will not be paid off until 2038".

3. There ultimately seems to be no risk (politically and economically) for lying or making mistakes about cost estimates. I'm not aware of any politicians who suffered for approving such drastic errors - and you can be sure the companies who got awarded the huge contracts can take care of any politician who helped them in the unlikely case such a person doesn't get re-elected.

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Frankly, realistically NOTHING can be done about such issues, unless your ruler happens to be Emperor Leto II Atreides.

Project Management as study discipline came up with several (or many) approaches to help, but ultimately the problems stem from human nature.

The two solution approaches would be:

• Strong policies to dis-incentivise overruns, for both politicians (immediate ban from political activity for lobbying for a bad project, with actionable clawbacks in salary); and for contractors (again, bans on any further government contracts; fee clawbacks; and immediate termination of contract once overrun reaches certain threshold, with requirement to get another contractor to complete)

• Automatically apply "project management inflation" rule of thumb mentioned above (cost *4, duration *3) to any estimates not backed up by both rigorous details of why they are accurate AND a history of a given contractor giving good estimates.

• Have project checkpoints at frequent intervals, that serve to calibrate costs/deadlines.

• Any other Project Management techniques that work (I'm not a PMP but I play one at my day job)

Answer 2

Government contracts typically fall into two primary categories:

• Fixed Price Contracts

• Time and Materials Contracts

As one can deduce from the names, a fixed price contract is just that - the vendor is given a certain amount of money, and and imposes fines and penalties if the desired bridge, software, space ship, whatever isn't delivered on time. The company that accepts this bet believes that it can deliver the good or service, plus a reasonable profit, for the fixed amount. Since the government's procurement policies often require acceptance of the lowest bid that it believes has a reasonable chance of successfully executing the project, it follows that this optimizes the tradeoff between risk and price.

The downside, of course, is that for unknown costs, many vendors are unwilling to to strictly abide by a fixed fee contract, and instead wish the ultimate risk to be borne by the customer, hence the "time and materials" form of contract. In order to entice vendors to take such a risk, they must either agree to reduce the risk or extend the profit. As such, even a fixed fee contract may not arrive at the lowest price but technically will arrive at the lowest cost, since other factors (including risk) are part of the cost even if they are not part of the price.

By definition, however, a fixed fee contract pushes the entire burden of a cost overrun onto the vendor. In exchange for this risk, a fixed fee contract will most likely entail a higher price than doing it ones'self.

Hybrids exist in which a fixed fee is guaranteed, but a certain amount of the risk is mitigated by a T&M contract.