world-wide adopt `admeasurement contracts in which the contract price is accumulated from competitively tendered unit rates (Smith and Wearne, 1993; Langford and Rowland, 1995; World Bank, 1995; Institution of Civil Engineers, 1996). The price nally paid is based on remeasurement of the actual quanti- ties of work completed. Commonly problems arise because unit rates do not represent the way in which all costs are incurred. Many signicant costs are related to both time and the method of execution. A signicant part of a con- tractors costs are time related. These are most affected by disruptions such as the effects of variation orders, and as such are a major source of claims and disputes (Merna et al., 1996). Variations are accepted as inevitable in much construction, as a project is usually only a means to an evolving end (Akinsola et al., 1997). Conditions of contract vary widely in their alloca- tion of such risks and the relationship between time and cost. None provides a truly systematic basis for the valuation of interim payments and change. The effects of time and of cost are considered separately. They may require two models, one for time and one for cost, or they may not have a rational basis at all, causing conict and promoting distrust between the parties. Payments are based on a complex `shopping list of rates, with the concept of a relationship between time and cost non-existent. This is an unrealistic assumption that causes problems for both parties, particularly in the event of a variation, so much so that the cost model, when used to assess compensation in the event of change, gives a false measure. The results are claims and conict. The concept of method-related charges introduced in 1973 by N. M. L. Barnes in revising the UK Civil Engineering Standard Method of Measurement (Institution of Civil Engineers, 1973) goes part way to resolving this problem, but no systematic procedure has been established for the evaluation of variations involving disruption and delay. As a result, there are many claims for additional payment and considerable effort is spent in their resolution. In many cases conict inhibits all collaboration between the parties to the contract. Construction Management and Economics (2000) 18, 263268 NOTE A systematic approach to the evaluation of indirect costs of contract variations DENISE BOWER Centre for Research in the Management of Projects, University of Manchester Institute of Science and Technology, P O Box 88, Manchester M60 1QD, UK Received 21 June 1999; accepted 11 October 1999 A mechanism is proposed for the evaluation of compensation due in the event of a variation order under contracts for construction work. It demonstrates how the indirect costs of a variation can be derived by the use of inuence curves. Commonly it is accepted that such costs are very difcult to evaluate systematically, and hence the parties to the contract have been left to argue over the cost and time effects of a variation and the compensation due. The technique suggested provides a simple solution to this problem. Keywords: Contracts, changes, variations, costs Construction Management and Economics ISSN 01446193 print/ISSN 1466-433X online 2000 Taylor & Francis Ltd The research project undertaken by the author was funded by the UK Engineering and Physical Sciences Research Council and jointly managed by UMIST and the University of Dundee. It was subject to the guidance of a steering group of clients, consultants and contractors. The results provide a new technique for the evaluation of indirect costs due to a variation, called `inuence curves by the author (Bower, 1996). Use of this technique should reduce the scope for argu- ments, leading to better relationships between client and contractor and more efciently run projects. The research concentrated on contracts for the construc- tion of bridges, roads and service reservoirs, that is, relatively low risk, low technology projects. Projects unique in nature, because of the level of technological development or high risks, were outside the scope of work as the nature of those projects might have biased the ndings of the research, but the approach adopted for the development of the inuence curves should be relevant for any form of construction. Thus the objective of the research was to develop a mechanism that would allow the systematic evaluation of direct costs associated with contractual variations. The effects of a variation When the scope of a job is varied many tasks may be affected both directly and indirectly. Additional costs due to the direct effects of a variation, such as a change in resource requirements, are relatively easy to esti- mate. The indirect effects which are difcult to quan- tify can include: rework and lost effort on work already done; time lost in stopping and restarting current tasks in order to make the variation; change in cash ow, nancing costs, loss of earn- ings, etc; loss of productivity due to reprogramming, loss of rhythm, unbalanced gangs and acceleration; revisions to project reports and documents; and loss of oat, therefore increased sensitivity to delay. It is common for the contractor to work to a programme that is not contractual. This further complicates the evaluation of compensation for the indirect costs of a variation. The time effects translate into a cost because either the contract duration will be extended, which means that overheads and nancing are increased, or the work has to be accelerated, leading to the inefcient use of resources. In 1993 Thomas and Napolitan stated that `there have been no denitive studies reporting in quanti- tative terms the impact of changes. Much attention has been given to payment mechanisms that allow for the speedy and fair evaluation of payments due to a contractor, but the development of such systems, except in the case of cost-reimbursable contracts, has not addressed the problem of the evaluation of indi- rect costs associated with change. Commonly it has been accepted that such costs are very difcult to eval- uate systematically. Hence the parties to a contract have been left to argue over the cost and time effects of the variation and the compensation due. Generally, the settlement of such costs has been left to the end of the contract period when all disruptive effects have been `rolled up together, and the compensation to the contractor has been bartered between the parties. The effects of this are that the contractor has no certainty as to the outcome of the negotiations and hence has to allow high contingencies against the outcome. This causes contention between the parties as the contractor is continually pushing the client to settle the claim for additional costs while invariably feeling that the reimbursement has been insufcient. This can be very damaging to relationships between all parties repre- sentatives. If partnering or alliancing is the policy for a project, the preparatory workshop which this requires provides a means of agreeing how to manage such claims (McGowan et al., 1992). In this research we sought a means of avoiding the occurrence of claims. The traditional method of settling claims for indi- rect costs is a `horse trade in which one party, normally the contractor, suggests a level of compensation for the variation, and then the other argues for adjustment of that amount. This method in itself would be difcult to justify if it related to individual variations, and normally it is undertaken for all of the changes at once at the end of the contract, when it is impossible to separate out the effects of any one problem. No attempt is made to quantify and cost all of the effects listed above. For example, additional management time will simply be costed as a percentage of the direct costs associated with the variation, with no attempt having been made to account for the fact that some- times variations having only a small direct cost effect can have a large indirect effect. These strategies are not systematic and they are all responsible for furthering the arguments between client and contractor and prolonging claims situations. Evaluating indirect costs A systematic approach to the assessment of indirect costs associated with a change needs to take account of those costs which arise due to a number of tasks being performed at the same time, whether they are logically linked or not, and the effects of `ripples through the programme due to logic links. These could 264 Bower be thought of as vertical and horizontal relationships within a bar chart programme, vertical links taking account of the control needed for a number of tasks to be live at any one time, and horizontal links being the more traditional logic links. Thomas and Napolitan (1993) described a `factor model which provides a means for understanding and quantifying the effects of change on labour pro- ductivity. The factor model does not take into account the `cumulative or ripple effect that occurs when project conditions have deteriorated to the point where work on a task is adversely affected by another task or by the mere nature of the site environment. Thomas and Napolitan went on to say that `no research has been conducted on the ripple effect, although it has been acknowledged quite often by construction professionals. Another systematic approach that has been taken in the assessment of these costs has been developed empirically by Fluor Daniel Ltd for use in process plant contracts (private communication). It is known as `Impact. It is applied to the estimate of additional direct costs, cost being cost to the client due to the variation. The approach of establishing a standard `inuence curve from which a factor could be sought in the event of a variation was believed by the author to be a systematic, rapid and equitable technique for indi- cating the indirect costs. In the research, curves were developed recognizing that different types of work may require different curves. Initially, research concentrated on producing a curve for road building. A numerical rather than an empirical approach was sought by which the curve could be derived. Further validation of the curves focuses on the establishment of a database of projects from which curves can be derived. It was important that the technique for curve devel- opment should be simple enough to be used by clients to derive their own curves for unique projects. Determining direct cost In the use of inuence curves cost is the cost to the client. Therefore whenever possible, rates tendered by the contractor should be used to assess the direct cost. If actual costs have to be used, an addition for prot should be made after the inuence adjustment, according to the terms of the contract. The inuence curve is then used to assess the indirect part of the compensation when there is a variation. The elements listed below, in order of increasing subjectivity, make up the cost associated with change. 1. Time and material related charges related to immediately affected tasks. 2. Recalculation of network, increased time-related charges and overheads. 3. Rework, standing time for subcontractors. 4. Timing effects, for example, winter working. 5. Ination, change to cash ow, loss of earnings, etc. 6. Management time, head ofce and site. The more of these included as a direct cost, the lower should be the inuence factor. For civil engineering it seems sensible to dene a direct cost as the change in cost associated with tasks whose resource usage is changed due to the variation, that is, tasks whose dura- tion is increased due to the variation. These affected tasks are apparent without recalculation of the network as long as the programme is clear. In cases where a subcontractor is already on site and it is not possible for him to perform other work, an allowance for standing time must be included as a direct cost. In effect the subcontractor will have to be paid time-related charges as though he was working, therefore constituting an extension to the duration of the task. The shape of the inuence curve The author aimed to derive inuence curves that could be used to evaluate the indirect costs of contract variation and that could be adopted as standard for certain types of work, such as road building. As many construction projects are unique by nature some clients may want to derive their own curves, so a simple derivation was sought that would allow users to verify for themselves the most appropriate shape of curve. Two approaches have been taken in the derivation of an inuence curve. They have both developed from the philosophy that there are two major inuences on the shape of the curve: (i)the more live tasks at any given time, the greater is the effect of a variation, and (ii) the less the scope available for reworking the programme, the greater is the effect of a variation. For the rst approach a variation is introduced to a project at various points in time and then the direct costs associated with that variation are assessed. The direct costs are then factored by the number of live tasks at that point in time (to take account of the ripple effect) and summed for the project. For the second approach the level of resourcing was assessed at various points in time then combined with the rigidity of the programme (rigidity being the lack of oat). The derivation of these curves is detailed below. It should be noted that once a satisfactory curve shape has been obtained it is used as a standard, and an inuence curve need be derived from rst principles Indirect costs of contract variations 265 only for projects that are out of the ordinary, as already stated. The simplicity of the technique means that if a client were unsure whether his project suited the criteria for a particular standard curve it would be relatively easy to derive a unique curve. A workshop for preparing for partnering on a project would provide the opportunity to agree the value of inuence factors appropriate to that project if the parties felt that they needed review. Simulation of the effects of risks identied at that workshop would indicate the compensation for indirect costs before an event, so allowing client and contractor to assure them- selves that the results would be equitable. Derivation of the inuence curve The derivation of the curve uses only the change in cost associated with tasks whose resource usage is changed due to the variation, that is, tasks whose dura- tion is increased due to the variation. In cases where a subcontractor is already on site and it is not possible for him to perform other work, an allowance for standing time must be included as a direct cost. In effect the subcontractor will have to be paid time- related charges as though he was working, therefore constituting an extension to the duration of the task. These were the direct costs. The other costs listed earlier become the indirect costs that the inuence factor takes account of. Approach A 1. Dene intervals at which analysis will take place. Shorter time periods are required from 20 to 65% of project completion time. 2. At a given time examine the programme and note all of the tasks that are live. Determine how many logic links each of those tasks has and how many of the live tasks are in the same category. The number of categories is deter- mined according to the phasing of the work. (For the purposes of this methodology a cate- gory is a work phase, and an example would be: preliminary work, category 1; roadworks, category 2; and tie-ins, category 3.) 3. Apply the disruption to the task with the most logic links. In the rst instance a delay of ve days was used, that is the duration of the task with the most logic links was extended by ve days. In instances where there is more than one task with a large number of logic links apply the delay to each in turn and note the largest change in project budget. 4. Whenever possible apply the change to a hammock rather than a task (general overhead hammocks are excluded in this example). 5. Calculate the percentage change in budget, i.e. (change in budget/original budget) 100. 6. Weight the percentage change in budget by a task multiplier dened as the number of other live tasks within the same category at the time of the disruption. If a hammock is being used then the multiplier is the number of other hammocks in that category plus the number of other tasks live in that category which are not spanned by the hammock. These gures should then be summed to give the weighted cumulative percentage change. This is plotted against time to give the inuence curve. The change in cost was translated into a percentage change from the original budget which was then factored by the number of other tasks in the same cate- gory that were live at the time of the disruption. This gave a weighted percentage change taking into account the vertical links or `ripple effect. The cumulative percentage change was plotted against time to achieve the effect of the inuence curve increasing with time. Once an inuence curve has been plotted it is used in the event of a variation by multiplying the direct costs associated with the variation by the inuence factor and adding this amount to the direct cost to give the total cost of the variation to the client. The shape of the curve was tested by using delays of differing dura- tions and each time the shape remained constant. The proposed inuence curve is shown in Figure 1. The shape of the curve was veried using approach B. Approach B In this case the curve is derived by summing oat and resource usage days. 1. Count the maximum number of days oat at day 1. 2. At specied time intervals count the number of days of oat remaining. This is calculated by assuming that tasks prior to the assessment date have actually occurred as late as possible without affecting the project end date and counting how many days oat are left. 3. For the derivation of an inuence curve it is the inverse of this that is of interest, or the rigidity: if the original number of days oat was F, then the rigidity is F x, where x = F for the rst period and x = 0 for the nal period. 4. At the same points in time as the oat is assessed the level of resourcing also must be noted. The number of labour days being worked on the site, including machine drivers, is calculated. 266 Bower 5. The rigidity and labour days are summed to give an inuence curve. Study of cumulative cost curves showed an envelope if the tasks are scheduled to take place as soon as possible and as late as possible. This envelope is at its broadest when the project is two-thirds complete and illustrates a number of points: (i) the wider the band, the more oat is available for rescheduling the tasks at any given point in time; and (ii) the narrower the envelope from project to project, the less scope there is for rescheduling tasks as the project progresses, consistent with the ndings of Hajarat and Smith (1992). The implications for inuence factors are that as the project progresses there is greater scope for the manoeuvre of individual tasks until a point approxi- mately two-thirds of the way through the project, but since many tasks are going on at any one time the effect of any change is large. The analysis of the cumulative cost envelope led to an investigation of the availability of oat as a project progresses, both total and free oat. It was found that the number of days available reduces to approximately 5% of the original amount with 25% of the project duration remaining. This reinforces the theory that although there are fewer tasks that may be disrupted, the scope for reducing the effect of change through the use of oat decreases. The other half of the theory behind the shape of the inuence curve when using this approach is that the amount of control required increases steadily until the project is about 60% complete and then, as the number of tasks decreases, the amount of control required falls off. In approach A the number of live tasks at any one point in time was measured to give an indication of this effect. The alternative approach taken here was to measure the number of men working at any one time. This required summation of the number of man-hours being worked at any given time through the project; machine operators were included in order to judge the full scale of the task. The rigidity (for total oat) and resource curves were combined (summed) to give an alternative inuence curve. This curve was almost identical in shape to the curve derived using approach A. Although the scope of the research was limited in terms of the number of projects that could be evalu- ated, it was encouraging to nd that both approaches resulted in a curve of the shape that the steering group had anticipated. Regarding the actual inuence factors the steering group agreed that if either the client or the contractor felt that the scale was inappropriate to them then new factors could be negotiated or bid. However, once the inuence factors have been agreed for a project then they should be xed. This does not dilute the effectiveness of the approach as the outcome would still be the same, that is, there would be a systematic approach to the evaluation of variations. Case study The project used to illustrate briey the use of the inuence curve consisted of the construction of two kilometres of a single carriageway rural road in North Yorkshire. The indirect costs associated with the change may be evaluated using the inuence curve shown in Figure 1. The rst variation was a disruption to the disposal of unsuitable excavated material. The contract price was 2 093 124. The scheduled accumulated price by the time of the change was 370 067, or 17% of the total. Using this gure, an inuence factor of 3% is given and so should be applied to the direct costs to give the total compensation due to the contractor. This gure may seem low as compensation for the disrup- tive effects, but the project is still at a relatively early stage of its development and so there is time for economic replanning. At this time the number of other live activities is relatively low, so the ripple effect will be minimal. The direct charges associated with this variation are: 1 no. wagon for 55 days = 14 850 and two days extra work from excavation plant = 5011, giving a total direct cost of 19 861. The total amount of compensation due to the contractor is therefore 19 861 3 1.03 = 20 457. The direct costs could be determined from a number of sources depending on the conditions of contract. The second variation relates to the reworking of the surface levels of a stretch of the road. The kerbing subcontractor was already on the site when the change was introduced, and therefore a charge for standing time was incurred. As the kerbing was delayed, the surfacing was disrupted. The surfacing subcontractor Indirect costs of contract variations 267 Figure 1 Inuence curve for a project was already on site, so again standing time has to be paid. In this example there were four classes of work which needed price adjustment. These are outlined below, with an opinion as to whether or not they constitute direct charges or are included in the inuence factor. Subbase direct charge involves actual work being done due to variation: of 1132. Kerbs direct charge direct delay due to vari- ation: of 4823. Surfacing direct charge systematic evaluation is possible: 14 207. Overheads indirect charge inuence factor accounts for change to indirect charges. The appropriate inuence factor should therefore be applied to 1 132 + 4 823 + 14 207= 20 162. When the variation was notied the project was 72% complete in terms of price, giving an inuence factor of 70%, and hence the total compensation due to the contractor is 1.7 3 20 162 = 34 275. Conclusions Existing methods of evaluating payment due for vari- ations cause disputes and conict on site and between all parties representatives. This conict needs to be removed. If the reputation of the construction industry is to be enhanced, encouraging investment, then the parties to the contract must have aligned goals. A goal that the parties share is to optimize their prots or improve their business performance. For the client this may mean working to a tight budget or schedule to meet constraints external to the project. To a contractor it may mean achieving an acceptable prot margin, enhanced by reduced nancing costs and a secure ow of cash into his organization. The optimum level of the inuence curve can be fully veried only through data collection of the indi- rect costs associated with contractual change: this requires dedicated research over a long period of time. The results from the different approaches taken in the curve derivation inspire condence that the inuence factors are robust. The simplicity of the derivation and the scope for negotiation before the work on site commences further support the use of the curves. The inuence curve method can prevent many of todays problems. It increases clients certainty as to the nal cost of a project. It increases the contractors cer- tainty as to the compensation he will be paid in the event of a change to the work. This general reduction in the nancial risks to both parties should lead to lower bid prices. The rapid evaluation of the payment due to the contractor would decrease the management effort required in the measurement and valuation process, reducing project overheads. This systematic technique should help the industry achieve the team working advo- cated in major reports and supported by many in the con- struction industry in the UK, USA and other countries (Latham, 1994; Construction Industry Board, 1997). Acknowledgements The research team are very grateful to Fluor Daniel Ltd and all the members of the Steering Group for their advice and ideas on this research. References Akinsola, A.O., et al. (1997) Identication and evaluation of factors inuencing variations on building projects, International Journal of Project Management, 15(4), 26367. Bower, D.A. (1996) Evaluating the Indirect Cost of Change, International Project Management Association Congress, Paris. 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Smith, N.J., and Wearne, S.H. (1993) Construction Contract Arrangements in EU Countries, European Construction Institute, Loughborough. Thomas H.R. and Napolitan C. (1993) Anatomy of a Construction Change in Proceedings of CIB-W65 Conference, Trinidad, pp. 1195203. World Bank (1995) Procurement of Works, The World Bank, Washington. 268 Bower