Construction Economics

       The PROJECT








Construction industry plays a vital role in the economy of any nation. It employs largest number of labour, materials and financial resources. Hence the necessity for the optimum use of these scarce resources. In addition, the construction activity precedes any social, business recreational activities. These construction economics has developed into a separate field distinct from design and construction.  This has led to the genesis of modern concept of quantity surveying functions. The quantity surveyor is called upon to render advice to the employer on various aspects of economy in construction from the stage of conception to completion of the project and even during the life cycle period. The employer will look for the value for the money spent by him. The Engineer/Quantity surveyor  therefore need to possess a thorough knowledge of the project, market conditions, availability of vendors and contractors to render his timely and independent advice to the employer.


What is construction Economics?
              Economics  is derived from the Greek word ‘Oikonomia’ (Oikos = house + Nomos = laws) meaning managing the home. The definition of economics is the “Social science that studies the production, distribution and consumption of goods and services”. The modern definition according to Lionel Robbins in 1932 states economics as a  “science which studies human behavior as a relationship between ends and scarce means which have alternate uses”.
            Construction economics is a branch of general economics. It consists of application of techniques and expertise of economics to the particular area of construction industry. Construction economics is concerned with man’s needs for shelter and the suitable and appropriate conditions in which to work and live. It seeks to ensure the efficient use of available resources and to increase the rate of growth of construction in the most efficient manner.

 Construction economics include study of the following:
Ø  Client’s requirements :
        a)  Structure meets the client’s needs
        b)  Design is within the available funds
        c)  Building is available on the specified date
        d)  Final cost closely resembles the estimate
        e)  Quality / safety ensured
Ø  How the new construction affects the surrounding areas. This will consider aspects of planning, general amenities affected
Ø  The relationship of space and shape. Influence of design on cost
Ø  Assessment of initial cost estimate that is sufficiently accurate which will be useful for comparison throughout the building process
Ø  The reasons and methods of controlling costs. The methods adopted will vary according to the nature of project. The methods adopted should be sufficiently accurate but flexible enough to suit client’s requirements
Ø  Estimating the life of buildings and materials. The emphasis on initial costs has moved to costs in use
      Other important aspects to be considered:
§  Role of surveyors, engineers and builders employed in the industry
§  Division of industry between the design and construction process
§  The size of construction industry, its relation with other industries and national economy
§  Types of developments undertaken
§  The types and sizes of construction firms, and the availability of specialist contractors
§  The variations in building costs and factors that influence variations, such as market conditions, regional locations
§  Physical /unique nature of the project
§  Organization of construction process
§  Method of price determination


Cost Information:
a)      Price books / Current Market rate data – These data needs to be updated regularly to take price escalations into account
b)      Monthly cost data – Cost information on cost of materials, labour rates, indices, market indicators and other information relevant to construction. Research has shown that in the periods of high escalation, the prices can change even in a month, during Govt. Budget proposals, policy changes of Govt.
c)      Construction cost indices – In Britain comprehensive construction cost information is supplied on reciprocal basis based on analysis of completed projects. In addition it also provides cost indices, cost studies, cost trends, monthly briefings. However in India such information is maintained by concerned organizations. RBI/ Ministry of finance, Govt. of India publishes price indices for building materials, fuel monthly/ Quarterly .
d)       Construction cost price indices – Labour rates are fixed by labour commissioners of respective states. Many companies are now a days maintaining cost data of completed projects in their archives which will be useful for determining cost of future projects.
e)      Priced bill of quantities – They provide a wealth of information. However such data must be carefully analyzed because


         Cost planning and cost comparison:
     Cost Planning: The aim is to inform the client on the economic consequences   of various designs to enable him to select the most appropriate solution. Following are some of the aspects of cost planning.
a)                  Planning Efficiency – Although length of bridge is similar the depth of foundations, height of piers and spans are different. The details of deck slab are different.
b)                   Constructional details – In order to advise the client, the planner will have to undertake cost studies of sensitive elements (Elements where alternatives make large change), technology, methods of construction. This will involve time and money.


Economics of Quality: ‘M’ factors affecting Quality
     Markets: Comparability between standards provided by different firms
     Men: Single most important factor in achieving quality, i.e. having right men
     Money: Quality costs money
     Management: It is the function of management to set company’s quality policy
     Materials: Specified correctly, properly delivered and checked at site, stored and used
     Methods: The method specified must be capable of being executed in practice to the tolerance and finish required.
     Machines: Selection of correct machine for the work being carried out to work efficiently


   Construction economics is concerned with making efficient use of limited resources to maximize output and satisfy greatest possible number of wants.
   Productivity of Economy:
Ø  Quantity & Quality of natural and manmade resources
Ø  Quality and extent of education and training of labour force
Ø  Levels of expectation, motivation and well being
Ø  Commitment to research and development

   Causes of Inefficiency in Construction Industry:
Ø  Industry demonstrates poor safety record
Ø  No real culture from learning from previous projects
Ø  Poor level of investment into R&D
Ø  Technology not used widely enough
    Construction Industry has four distinct Qualities:
Ø  Physical nature of the product is large, heavy and expensive and often one off
Ø  Dominated by large number of relatively small firms spread over vast area
Ø  Demand for activity directly determined by general state of economy
Ø  Method of price determination is usually complex due to tendering process used in various stages. As a result of poor management, construction firms may have cost over runs (20-30%). Clients fell short of revenues by 30-40%.
    Sustainable Construction:
Ø  Efficient use of resources
Ø  Effective protection of environment
Ø  Economic growth
Ø  Social progress that meets needs of every one

   Construction process is a world of as if:
Ø  As if client knew what he wanted when he commissions the structure from a designer
Ø  As if the designer was in a position to advise the client on the best value for money he could obtain from the market
Ø  As if the contractual procedures were devised to ensure that the client could get the best possible deal from the profession from the market place
Ø  As if the manufacturer of construction materials and components know in advance what is expected of him and geared his production to such expectation
Ø  As if the contractor knows how his resources were used, was in a position to control them and was able to use this experience on his next project (Complex, Fragmented and Conservative nature). Construction economics should therefore favour models that prioritize strategies and improve sustainability, competitiveness, productivity and value to clients.
Ø   Investment criteria: (Discounting Methods)
Ø  Net present value (NPV): It is the sum of the present values of all cash flows-positive as well as negative-that are expected to occur over the life cycle period of the project.


   Investment criteria: (Discounting Methods):

   Benefit cost ratio:

                                                Present value of benefits (PVB)
   Benefit cost ration (BCR)= -----------------------------------
                                                Initial Investment (I)


   Net benefit cost ratio (NCBR)= BCR – 1
   Criteria:
   When BCR                 Or NBCR            Rule is
     > 1                                > 0                  Accept
     = 1                                = 0                  Indifferent
     < 1                                < 0                  Reject


   Internal rate of return (IRR): It is the discount rate which makes its NPV equal to zero. Put differently it is the discount   rate which equates the present     value of future cash flows with the initial investment.






Urgency: Projects that are deemed to be more urgent get priority over projects that are regarded as less urgent.
E.g. Replacement of a machine that has failed and the major work is stalled.
Payback period: It is the length of time required to recover the initial investment on the project






Accounting rate of return: The accounting rate of return, also referred to as average rate of return on investment, is a measure of profitability which relates to investment, both measured in accounting terms.








     Value Engineering and Value management:
Ø  Value management is a strategy for identifying the project that provides the best value for money through the best use of limited resources that are available
Ø  As per Lawrence  De Miles, GEC USA, the originator of value engineering, ‘It is an organized approach to providing the necessary functions at the lowest cost’

      Some of the questions asked in value management are:
1.      What is it?
2.      What does it do?
3.      What is it worth?
4.      What does it cost?
5.      What else will do?
6.      What does that cost?
      In the development of value management following are encouraged:
§  Protect those in the group who are vulnerable
§  Listen to other’s point of view
§  Eliminate status or rank
§  Value the learning in mistakes
§  Set up win-wins
§  Share the risk
§  Assume it can be done
§  Take on faith


     Cost Studies: Cost sensitivity -  The cost sensitivity of an element is dependent on the cost of the element to the total cost of the building. For any element to be cost sensitive, any change in its cost must significantly affect the initial building cost. The element is  cost sensitive as regards quality and performance only where the quantity factor is high and how sensitive depends on combined costs of other elements.

     Development Economics: Various sources of funds:
a)      Owner’s capital – This includes retained earnings in the form of profits, and is the most economical source, should it be available. The use of trading funds, deferred expenses for goods and materials or money set aside for taxation purposes may also be available in the short term.
b)      Bank overdraft – This is unlikely to be available as a source of finance for building development. This may be available for bridging purposes. High rates of interest are generally charged by banks.
c)      Loans – This is a long term loan at a lower rate of interest. It is common for small firms to obtain this form of loan from banks. However a large organization may choose an insurance company, or a financial corporation.
d)     Shares – Property companies are able to raise capital by selling shares to purchasers who then receive a share of the profits when distributed. There are two types of shares.
e)      Hire purchase and leasing – If a firm has insufficient capital for both equipment and development, it can obtain the capital by hire purchase, which is in effect a loan, and so as to release its capital for development. The firm may choose to lease the equipment for a minimum period, with an option to purchase at the end of the time period.
f)       Installment finance – Major building works are paid for on the basis of interim payments. The price of the project is paid for on an installment basis, usually representing 90% of the value of work complete. Payment by this way helps to reduce the borrowing requirements. The developer, where he is not the contractor, may be able to offset these sums by either forward selling or pre-selling methods, where monies are received in advance of completion.

Note:
      Preferential shares: These carry a fixed rate of interest which shall be paid irrespective of whether the company makes profit or not.
     Equity shares – The profits/ dividend are paid to the    purchasers equally only after the dues to preferential shares/ debentures are paid in full. Even if the company goes into liquidation, all the dues of debenture/ preferential holders are paid in the first instance.
     Debentures – These are essentially  loans to the company at a fixed rate of interest and do not allow their holders to vote. They must be paid first irrespective of whether the company makes profit or loss.


      Life Cycle Costing:
1.      Understand the principles that affect the buildings life
2.      Identify the factors that affect the physical deterioration of buildings
3.      Consider the different forms of obsolescence that affect property
4.      Recognize the variability in the lives of building components
5.      Identify the problems that are inherent with component life data
6.      Understand the relationship between inflation, interest rates and discount rates
7.      Recognize the significance of taxation on the whole life costing calculations


      Lean Construction:
      Eliminate waste: It can include mistakes, working out sequence, redundant activities and movement, delayed or premature inputs and products & services that don’t meet customer needs.
      Primary focus is on moving closer to providing product that customer really wants by understanding the process  including identifying waste within it and eliminating step by step
      Designing is identifying the right product in terms of customer needs and then designing it correctly as coherent buildable products and not just styling the exteriors. Design development target shall include reducing design changes and process iterations.
      Precisely specify value from the perspective of ultimate customer. Clearly identify the process that delivers what the customer values and eliminate all non value adding steps.
      Pursue perfection by continuous improvement


Reconciliation

 

 

 

             All civil Engineering works invariably require various material for incorporation and completion of work. These materials could be procured by the Employer or the contractor. In some cases the employer stipulates that certain materials would be issued by him and the contractor should quote for the work accordingly. In other cases the employer may leave procurement of materials to the contractor.

              In both these cases, the material need to be accounted in the bills for payment. This is a very important function of quantity surveyors and executives. Non reconciliation will result in delay in clearance of bills as well as recoveries as per conditions of contract. Some organization may stipulate recoveries for non reconciled materials at penal rates of recovery

     

 

     What is Reconciliation?    

     It is the process of comparing the standard data with actual data after considering data relating to variances.

 

      E.g. Suppose 100 MT of  16mm dia. TMT steel bars of Fe-500 grade are procured.  Assume that the weight of the bar received  is 1.63 kg/ Rm. The  weight variation details of the consignment are as follows:

 

Total weight of steel received    1,00,000 kg

Standard weight of steel            1.58 kg/m

Length of steel received         1,00,000/ 1.63

= 61,349.693 m (Actual weight 1.63 kg/Rm.)

Length of steel as per standard weight  1,00,000/1.58 = 63,291.139m

Loss of weight  0.05/1.58 = 3.16%

Weight computed by measurement and std. wt.

=61,349.693 x 1.58 = 96,932.50 kg

Loss of weight = 3067.50 kg

 

Other aspects:

Ø Off cuts

Ø Scrap

Ø Improper bar bending

Ø Cutting loss

Ø Laps

Ø Chairs

Ø Spacers

Ø Miscellaneous usages

 

 

Issue of materials by Employer:

§ Estimate the sizes and quantities of materials

§ Procurement

§ Check on receipt from supplier with regards to correct size, quality and quantity and weight

§ Account these materials in the material ledgers with all the characteristics

§ Issue to contractor against indent specifying the quantity (Units, Tonnage, length etc.)

 

Procurement of Materials by contractor:

§ Estimate the sizes and quantities of materials

§ Get approval for the source of supply from Employer, and procure

§ Check on receipt from supplier with regards to correct size, quality and quantity and get them checked by employer

§ Account these materials in the material ledgers with all the characteristics

§ Issue to work site

 

Preliminary check of materials:

Ø Check for quality

Ø Check Size, unit weight, physical Characteristics and keep record

Ø In case of steel the unit weight of steel will be assessed by weighing random samples/ weighing a bundle and comparing with standard weight as per BIS and working out variance for conformity within tolerance

 

Incorporation of materials in work:

Ø Study the drawings and specifications and prepare method statements

Ø Prepare BBS/ shop drawings for steel items to conform to Architectural/ structural drawings

Ø Get them approved by Employer/consultants

Ø Check availability of material and examine how best cutting could be done to minimize wastage

Ø Fabricate and erect

Ø Correct the BBS on incorporation in the work before pouring concrete

 

Joint Measurements:

Ø  Preliminary check and approval by structural Engineer/ Architect/MEP consultant

Ø Preparation of joint measurements after checking the respective drawings and as provided at site

Ø Record any additional provisions  required at site but not shown in GFC drawings

Ø Assess the quantities in the respective units as per BOQ

 

Measurements for payment:

Ø  For completed items of work joint measurements will form the basis

Ø Joint measurements will be signed by both the parties

Ø For additional items of work not covered in BOQ a separate detail will be kept

 

   Issue of materials by Employer and Reconciliation in Running bills:

Ø Prepare the list of stores issued. If it is steel, the issue must show the weight of steel issued, the size, length, and number of bars

Ø Alternately, the unit weight of steel shall be assessed based on actual weight of random samples or bunch of bars. This weight need to be compared with standard weight as per BIS.

 

 

   Issue of materials by Employer and reconciliation in Running bills:

Ø The difference between actual weight and standard weight shall be kept in the issue register

Ø This procedure need to be repeated for each fresh consignment and for each size of bar

Ø The contractor/subcontractor must be charged at standard weight only

 

   Issue of Materials by Employer and Reconciliation in Running bills:

Ø The difference of weight has to be borne by the employer and written off from the materials ledgers periodically so that ground balances tally with ledger balances

Ø If the figures do not tally the matter should be investigated further and corrective action taken

  Issue of Materials by Employer and Reconciliation in Running bills:

Ø Contractor shall be asked to submit reconciliation statement with each bill or at periodicity as specified

Ø Off cuts/scrap should be defined. E.g. Steel bars above 1.5m can be considered as off cuts and below could be considered as scrap

Ø The off cuts and scrap shall be periodically verified jointly by rep. of employer and contractor.

 

 

   Issue of Materials by Employer and Reconciliation in Running bills:

Ø Other items like cement bags, pipes, fittings, shuttering plates, masonry blocks etc. could be counted in numbers and accounted

Ø If reconciliation statement is not submitted suitable amount needs to be withheld in the bills

 

   Issue of Materials by Employer and Reconciliation in Final bill:

Ø In the final bill all materials issued by the employer must be accounted. The bill can’t be progressed unless the reconciliation statement is not submitted

Ø Base percentages for wastages, scrap shall be specified in the contract Agreement

Ø For unaccounted materials penal recoveries shall be effected

 

   Materials Procured by contractor and Reconciliation in Final bill:

Ø For  material procured by contractor the contractor need to produce purchase vouchers, transport challans, test certificates, gate passes or any other proof required by the employer to satisfy that the materials conform to specifications and requisite quantity of material was brought to site and actually incorporated in the work

 

   Reconciliation of work done: Similar to accounting done for the materials, the work done need to be compared with the BOQ or the base estimate. The base estimate may consist of abstract quantities and rates. The actual work may consist of either sub contractor’s work or materials supplied by employer, labour rates, machinery charges, taxes, royalties and other miscellaneous charges.

 

 

   BOQ as a Base estimate: If the contract is based on BOQ it can be taken as base estimate and comparisons could be made with actual work done. If the contract is based on lump sum the estimate made subsequently will be taken as base estimate. The purpose of this comparison is to find out the variances from the base and to monitor and control the variances

 

 

 

 

 

   Actual work Done: The actual work could be carried out through a sub contractor or by the main contractor by supplying the main resources like materials, equipment, shuttering etc. and the sub contractor may be asked to provide necessary labour. In such cases the value of work done could be aggregated and other incidentals and taxes are added.

    Variances:

Ø Earned value of work done is assessed by measuring the quantity of work done. This is done item wise and compared with contract quantity. The difference is treated as quantity variance and converted into amount by multiplying with contract rates.

 

    Direct cost variance= Standard cost- Actual cost

Ø Work change orders are shown separately

    Variances:

Ø Material incorporated will be assessed and compared with standard quantity and rate

   Material cost variance= Standard cost- Actual cost (Material usage variance + Material price variance)

Ø Equipment used in the work will be assessed and compared with standard productivity cost

    Equipment variance = Standard cost- Actual cost

 

 

 

 

Cost for 4 Rafts

Std. Rate for one Raft

Std. Cost for 4 Rafts

Actual Cost for 4 Rafts

Description

Unit

SR

Qty

Std. Cost

Qty

Actual Cost

1

Material

5,000

326.4

16,32,000

330M³

17,16,000

2

Labour

400

-do-

1,30,500

-do-

1,40,250

3

Eqpt.

80

-do-

25,112

-do-

25,112

4

shuttering

200

-do-

65,280

-do-

60,000

Total Cost

18,52,892

19,53,962

Note: Standard quantity of 4 rafts, each 80 M3 plus 25 WASTAGE = 4 X 80 X 1.02 = 326.40

COST DATA FOR CASTING FOUR RAFS

 

 

Category

Std. Cost

Actual Cost

Variance

Material

16,32,000

17,16,000

-84,000

Labour

1,30,500

1,40,250

-9,750

Equipment

25,112

25,112

0

Shuttering

65,250

60,000

+5,250

18,52,862

19,41,362

-88,500

(-) 4.80%(Unfavourable)

                       Summary of Cost Data     

 

 

 

 

 

 

 

 

 

   Analysis of Earned value: From cost variances of work done, materials incorporated and equipment employed the earned value will be analyzed and corrective action taken to ensure profitability. This is basically the duty of quantity surveyor  to bring out possible loss of profitability to the Management at periodic intervals.

 

 

   Case Study: Reconciliation of steel issued in a Real Estate multistory building:

   Brief description of project: The project is 15 story residential RCC framed building having 10 flats in each floor. The building has sub cellar and cellar for parking. Various sizes of Fe 500 TMT steel was issued. The issues size wise are shown below. Reconcile the steel statement and offer comments. The work is still in progress.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Reconciliation Statement up to 12th RA bill: Unit: MT

Sl. No

Description

8mm

10mm

12mm

16mm

20mm

25mm

32mm

1

Total issue

314.3

180.36

30.93

222.3

339.0

193.9

28.86

2

Consumption

272.7

172.37

26.74

184.28

282.76

174.35

25.33

3

Work in progress

11.86

Nil

0.65

6.73

12.98

5.37

Nil

4

Full lengths

15.00

Nil

Nil

4.00

26.50

10.00

3.00

5

Cut lengths

1.00

Nil

0.50

3.00

3.75

3.00

0.17

6

Scrap

Total

9.40

309.96

5.00

177.37

0.85

28.74

3.60

201.61

5.10

331.09

Nil

192.72

Nil

28.50

 

 

 

  Notes:

Ø   Total steel issued     1309.65 MT

Ø Total quantity of scrap  23.95 MT

Ø Lengths indicated are as actually measured or based on random  sample weight on receipt of steel from Visakhapatnam steel Factory against each consignment