Cost Overrun and Demand Shortfall
Cost overruns and demand shortfalls frequently haunt public works projects. The main causes of cost overrun and demand shortfall are optimism bias and strategic misrepresentation (Flyvbjerg et al. 2002, 2005). Reference class forecasting was developed by Bent Flyvbjerg, Oxford University, to curb optimism bias and strategic misrepresentation and thus arrive at more accurate estimates of costs and demand. Daniel Kahneman, Nobel Prize winner in economics, calls Flyvbjerg's counsel to use reference class forecasting to de-bias forecasts, "the single most important piece of advice regarding how to increase accuracy in forecasting," including of costs and demand
According to research conducted at the Aalborg University, 86% of public works projects end up with cost overruns. Some unexpected findings of the research were that:
- Technically difficult projects were not more likely to exceed the budget than less difficult projects
- Projects in which more people were directly and indirectly affected by the project turned out to be more susceptible to cost overruns
- Project managers generally did not learn from similar projects attempted in the past
Generally contracts awarded by public tenders will include a provision for unexpected expenses (i.e. cost overruns), that typically amount to 10% of the value of the contract. This money is only spent during the course of the project if the construction managers judge that it is necessary, and typically the expenditure must be justified in writing.
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