Cost implications of variations in design decisions

It is widely believed that cost discrepancies or distinction arise mostly at construction stage. In certain other situations, variations occur as a result of time lag between the completion of the design and the time the client is ready to start construction.

However, the problem of cost overrun, especially in the construction industry, is a worldwide phenomenon, and its ripples are normally a source of friction between clients and contractors on the issue of price variation. If this friction is not properly handled, this could stall the progress of work and may subsequently lead to project abandonment. Although the causes of project cost overrun are well known, the methodology used in handling its evaluation, especially on those aspects relating to price variation, is very inadequate.

This research is aimed at understanding what variation is, outlining cost inferences of variations in design decisions and developing a suitable model for the evaluation of cost overrun during project execution, focusing primarily on cost effect and control with respect to the extent of work done.

INTRODUCTION

These general principles apply to contracts for construction work and to agreements for related services. For simplicity, the term “Contract" is used to encompass both construction contracts and service agreements and the term “Contractor" is used to include contractors, consultants and project managers. The term “Principal’s representative" means the Principal’s authorized person or the Principal’s Representative as applicable.

The general conditions in each standard form of contract define what constitutes a variation in that particular standard form. In general terms, a variation is a change to the work required under the Contract. For a construction contract, a variation is usually defined as a change to the Works. Each standard form contract also includes other provisions relating to variations and their management, which should be read in conjunction with these general principles.

If the Principal’s representative instructs (directs) a variation, the Contractor is obliged to carry out the instruction. The Contractor is generally not entitled to change the Works without agreement confirmed in writing by the Principal’s representative. A variation should generally be consistent with, or similar in nature to, the work under the Contract.

A variation becomes part of the Contract and all the contract conditions apply to the changed work, including provisions for extensions of time and site conditions (if applicable).

A variation instruction will often lead to claims from the Contractor for additional payment and for an extension to the period for completion. The additional payment may include additional costs for delay, acceleration and/or disruption associated with the variation. Variations are one of the main reasons for cost and time overruns in construction contracts.

It is therefore important to manage variations effectively in order to reduce the risk of exceeding the budget and completing the Works late.

Ideally, to meet the project budget and program, no variations will be directed during the course of the Contract. The scope of the work under the Contract will have been approved by the client agency before the contract is awarded and should not be changed without good reason. Note that it is not a role of the Principal’s representative to “improve" the approved design.

VARIATIONS

A variation is a change to the work required under the Contract and as a result, its implications (a subsequent change) in cost.

The Architect holds control over what the builder is being asked to build at all times.

Variations are only valid if they are recorded in writing, and signed by the architect and are delivered to the contractor’s registered office.

Instructions given by the client to the site labourers will NOT count as variations because clients and labourers do not always anticipate the full implications of the changes they propose (for example, cost, programme, and safety implications to name but three).

Work which the contractor decides to do without having received a valid instruction from the architect will NOT count as a valid variation, and will not be paid for.

The architect can give instructions verbally to the workers on site but such instructions are only valid if backed up by a formal written (and signed) variation which should be issued within 7 days.

If the clients want to vary some aspect of the work they must communicate with the architect first, who will advise them on the likely time/cost implications of the change and will then issue instructions to the contractor as appropriate. For effective project management this process should NEVER be short-circuited.

Properly written and signed variations issued by the architect are called Architect’s Instructions. They are usually issued on bright orange paper so that they can’t be overlooked or mistaken.

TYPES OF VARIATIONS

A variation can be categorized as one of the following:

An unavoidable variation;

A variation for the convenience of the client; or

A variation for the convenience of the Contractor (or Consultant).

Unavoidable Variations

Unavoidable variations are necessary in order to minimize adverse effects due to unexpected events or circumstances. They may be required to avoid health, safety or security problems. They do not result in a change to the scope of the work.

Examples of unavoidable variations are:

a variation to minimize the increase in cost or other adverse impact of a latent condition (for example unanticipated ground conditions, hazardous materials or existing services),

a variation to overcome a fault (for example an error, ambiguity or inconsistency other than an omission or lack of completeness which may be the responsibility of the Contractor) in the Principal’s design or documentation which, unless it is remedied, could result in health, safety or security problems or prevent work from continuing,

a variation to overcome a change in statutory requirements that has occurred since tenders closed.

A failure to give an instruction in the above circumstances may prevent the Contract from being completed and may therefore be a breach of contract by the Principal.

The client must be made aware of the consequences of failing to respond promptly to situations generating unavoidable variations. If an instruction is not given promptly in response to the circumstances giving rise to the necessity for the variation additional extra costs will often be incurred, for example for delays or rework.

Variations for the convenience of the Client

Variations for the convenience of the client are variations requested by the client due to a change in the client’s requirements. They are not unavoidable variations in that it is possible to complete the Contract without making the changes requested.

Variations for the convenience of the client will change the scope of the work and almost always increase the cost of the work. Even variations that appear to reduce the scope may increase the cost. This is because variations are valued by adding the cost of the extra work, plus a margin, and subtracting the contractual value of the work taken out of the Contract.

The actual cost of the added work can often be greater than the contractual value of the work taken out of the Contract. There may also be associated costs for rework, delays and disruption.

Variations for the convenience of the client cannot be instructed unless adequate funds are available and have been approved. The funds must be sufficient to cover all costs associated with the variation, including all the Contractor’s costs and associated fees and charges.

The client should undertake that it will not order a variation for the convenience of the client unless it has been advised of the full cost and time implications of the variation and has approved and provided funding to cover all impacts, including any increase in the project management fee.

Variations for the convenience of the Contractor

Variations for the convenience of the Contractor are variations that are requested by the Contractor. They are not unavoidable variations.

There is no obligation on the Principal to agree to a variation for the convenience of the Contractor. However, it may be beneficial to the project. When a request is made, it should be considered if only to maintain good contractual relationships.

The Contractor should be required to provide sufficient detail to permit proper evaluation.

Variations for the convenience of the Contractor are not to be instructed until the full impacts have been agreed and the Contractor has taken responsibility for ensuring there are no adverse impacts on the rest of the work.

The client may either authorize the Principal’s representative to approve variations for the convenience of the Contractor at that person’s discretion or the client may agree to respond quickly to requests for such variations. If such a variation involves additional costs, then the issue of an instruction must be subject to the agreed financial delegations.

INSTRUCTING VARIATIONS

When the Principal’s representative instructs the Contractor to carry out a variation, the resulting change to the work becomes part of the Contract.

If the Contractor requests approval to a variation, before instructing the variation, ask the Contractor to advise whether the variation is an unavoidable variation or a variation for the convenience of the client or the Contractor.

The following principles should be applied to all variations:

instruct a variation only within the general scope of the Contract, unless the Contractor agrees otherwise an instruction can only be given by the Principal’s representative

the instruction must be in writing

before instructing a variation, unless the instruction is required urgently in order for the work to proceed, request the Contractor to advise the cost and time impacts of the proposed variation

where possible, instruct a variation only after the full cost and time implications have been evaluated and agreed in writing with the Contractor (the instruction will constitute approval to the cost and time impacts agreed with the Contractor)

do not alter a Contractor’s written quotation without the agreement of the Contractor. If there is a change agreed, it is preferable to have the Contractor submit a revised quotation. Alternatively, if verbal agreement is reached, confirm that agreement in writing

include in the instruction a brief description of the variation work and a requirement that the work is to be undertaken in accordance with the identified instruction, the Contract Documents or any other document referred to in the instruction. It is sufficient for the instruction to give only a short summary of the variation if reference is made to other documents describing the agreement in detail

instruct a variation only if it is within the authority delegated by the client and sufficient funds have been confirmed as available

if agreement to cost and time cannot be reached before the commencement of an unavoidable variation, attempt to reach agreement at the earliest possible time

if agreement cannot be reached on a variation that is not unavaoidable, consider whether it may be preferable to defer the change to the Works to a later date so it can be more economically done by others.

do not instruct a variation after Completion unless the variation is for the purpose of dealing with defects

The following additional requirements are applicable to the different categories of Variations.

Unavoidable variations

It may be necessary to give an oral instruction if a variation is unavoidable and urgent action is required due to event(s) or circumstances, for example if there is a safety hazard that requires elimination. If an oral instruction is given, confirm the instruction in writing as soon as possible under the authorization protocols (including confirmation of funding) agreed with the client.

Variations for the convenience of the client

Before instructing the Contractor to carry out a variation for the convenience of the client, advise the client that it will be necessary to ask the Contractor for the full cost and time impacts of the variation and request the Contractor to provide these details.

If the Contractor provides these details, pass them on to the client for authorization of the additional expenditure and time, if applicable, before instructing the Contractor to carry out the variation. If the Contractor is unable or refuses to advise the full cost and time impacts, then inform the client.

For a GC21 contract, a Valuer can be engaged to determine the cost and time impacts of a variation. Note that the Valuer’s determination is binding if it is less than the amount specified in Contract Information.

If a variation is instructed without the Contractor committing to a price, there is a high risk that the cost will exceed an estimate prepared by others.

Variations for the convenience of the Contractor

It is most important that variations for the convenience of the Contractor are not approved unless the Contractor agrees as a minimum, in writing, that:

the Contractor will not be entitled to additional remuneration (no increase in the contract price) on account of the variation or its impacts on the work under the Contract;

the Contractor will not be entitled to an extension of time as a result of the variation,

the work under the variation will be fit for purpose and

the variation will not result in any other variations being required.

Grant approval to variations requested by the Contractor for the Contractor’s convenience only after it has been agreed in writing that there will be no increase in the time to complete, and either no extra cost or a reduction in the cost of the Works.

It may be necessary to refer proposals for variations for the convenience of the Contractor to the designer of the Works for consideration before confirming agreement.

VALUING VARIATIONS

The cost of a variation can be considered to have three components: direct costs, indirect costs and consequential costs.

Direct costs are the costs of the actual performance of the work and usually include the costs of labour, plant, materials and subcontract work.

Indirect costs might include overheads, administration, supervision, attendance and profit. These are often covered by a margin prescribed in the Contract.

Consequential costs might be incurred as a result of disruption to the work, delay to the program or some critical activity in it, or inefficiency created by undertaking work out of the planned sequence.

An assessment of the total cost of the variation takes into account all the above components.

A variation instruction may be to carry out additional work, to delete work or a combination. To properly assess the Contractor’s quotation, details of the cost of the extra work and the cost of the deleted work should be identified separately. Do not accept quotations that include “extra over" costs without identifying the costs of each item of work involved.

Variations deleting work from the Contract

If the variation involves omitting or deleting work from the original scope of work,

the method of determining its value will depend on whether:

the value of the deleted work is not identified in the Contract or

the deleted work has a separate lump sum price identified in the Contract

(for example, In a Schedule of Rates & Lump Sums).

If the deleted work has to be valued from first principles because its cost is not identified in the Contract, then a margin should be added to the calculated direct costs to determine the amount to be deducted from the contract price. This allows for the supervision and associated costs that will not be incurred by the Contractor if the work is not carried out.

If the deleted work has a separate lump sum price, then the amount deducted due to its omission would be less than the lump sum price. This is because the tendered lump sum price is assumed to cover some indirect costs that will be incurred by the Contractor whether or not the work is carried out. These costs might include a proportion of the site establishment costs, depending on the breakup of costs in the particular contract.

However, there are other costs, such as direct supervision of the work or administration of subcontracts that will not be incurred if the work is deleted. The deduction for deleted work is therefore less than the quoted lump sum amount and more than the direct cost of labour, plant, materials and subcontracts involved in carrying out the work.

It is important to note that the Contractor is not entitled to recover any profit on work that is deleted from the Contract.

EFFECTS AND CONTROLS FOR POTENTIAL CAUSE OF VARIATIONS

Based on a Research study, by the Department of Building, School of Design and Environment, National University of Singapore, the study presents a Knowledge-Based Decision Support System (KBDSS) developed based on the data collected from 79 institutional buildings, for making timely and more informed decisions for management of variations.

The micro layer is the second segment of the knowledge-base that contains 79 sub layers based on the 79 institutional projects respectively. As shown in Exhibit 7a and 7b, the micro layer contains the detailed information regarding variations and variation orders for the institutional project. The detailed information includes the variation order code that assists in sieving information, detailed description of particular variation collected from source documents, reason for carrying out the particular variation provided by the consultant, root cause of variation, type of variation, cost implication, time implication, approving authority, and endorsing authority. Here, the information regarding the description of particular variation, reason, type of variation, cost implication, time implication, approving authority, and endorsing authority were obtained from the source documents of the 79 institutional projects. The root causes were determined based on the description of variations, reasons given by the consultants, and the project source documents and were verified later through the in-depth interview sessions with the professionals who were involved in these projects.

Exhibit 7a Micro layer of the knowledge-base that contains the detailed information regarding variation orders for the institutional project

Exhibit 7b Micro layer of the knowledge-base that contains the detailed information regarding variation orders for the institutional project

The third layer of the KBDSS contains 53 sub-layers based on the potential causes of variations and 10 sub-layers of most important causes combined. The 53 causes can be modified in the event that new ones are discovered or emerged over time. The numerous filters provided in the macro, micro, and effects and controls layers will be updated automatically with every new project added. As shown in Exhibit 9, the graphical presentation of the 5 most important effects and 5 most effective controls for the cause of variations was presented. An understanding of the effects of variations would be helpful for the professionals in assessing variations. A clearer view of the impacts on the projects will enable the project team to take advantage of beneficial variations when the opportunity arises.

Eventually, a clearer and comprehensive view of the potential effects of variations will result in informed decisions for effective strategic management of variations. It is suggested that variations can be reduced with due diligence during the design stages. Furthermore, the suggested controls would assist professionals in taking proactive measures for reducing variation orders for institutional building projects. As mentioned earlier about the design stage, it is recommended that the controls be implemented as early as possible. The controls selection tab is provided in the CDP form. This feature assisted in linking the knowledge-base with the decision support shell. This is required because the professionals may not be able to implement all the suggested controls.

Therefore, the shell assists them in selecting the most appropriate controls based on their own criterions.

Exhibit 9: Effects and controls layer of the knowledge-base that pinpoints the most important effects and most effective controls for each cause of variations

Structured Process for Selecting Suggested Controls through Decision Support Shell

The decision support shell is integrated with the knowledge-base to assist the user in selecting the appropriate controls of variations. As mentioned in the previous section, the 5 most effective controls for the cause of variations were presented on the effects and controls layer, and the layer was linked with the controls selection shell. The decision support shell provides decision support through a structured process consisting of building the hierarchy among the main criterions and the suggested controls, rating the controls, and analyzing the controls for selection through multiple analytical techniques, for instance, the analytical hierarchy process, multi-attribute rating technique, and direct trade-offs. The decision support shell contained four layers that were based on the structured process of decision making, namely, control selection criterions, building the hierarchy between criterions and controls, rating the controls, selecting the best controls based on the given criterions.

Exhibit 10: Main panel of decision support shell that contains the goal, main criteria and the most effective controls for variations (focusing on Time, Cost and Quality)

As shown in Exhibit 10, this layer of the decision support shell contains the suggested controls for the cause of variation selected in the controls and effects layer of the KBDSS. Hence, the decision support shell contains 53 layers based on the each cause of variations and their most effective controls. Here the goal was to select the controlling strategies and the main criterions were time, cost and quality. In this layer, the professionals may add any suggested controls that are considered to be important. Furthermore, the professionals may specify their own contemporary criterions for selecting the controls. The provision of the facility for adding more controls and criterions would assist them in evaluating the suggested controls according to the project stages and needs. This may assist them in selecting and implementing the appropriate controls at appropriate time.

The main objective of this layer is to generate the hierarchy between the main criterions and the suggested controls for variations. The shell generates hierarchy among the goal, the criterions and the suggested controls as shown in Exhibit 11. The hierarchy assists in rating all the suggested controls. Exhibit 11: Building the hierarchy among the goal, main criteria and controls for variations

CONCLUSION

Although every construction project has its own specific condition, professionals can still obtain certain useful information from past experience. This information will enable building professionals to better ensure that their project goes smoothly without making unwarranted mistakes, and it should be helpful to improving the performance of the project. Furthermore, it is imperative to realize which variations will produce significantly more cost variation effect for a construction project.