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