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Case study

Determinants of project performance in the Russian construction industry


A strategic project management perspective

Introduction
real estate development projects in the Russian construction industry consistently struggle with budgetary constraints and schedule overruns. Budget overspends degrade project value, while schedule overruns delay the time to market. Both result in increased overheads and higher financing costs, as well as lost revenues that further reduce a projects value. Moreover, these performance problems also strain the relationships between developers and contractors, which can lead to protracted contractual disputes. For instance, in a rising market, failure to complete the project on schedule could doom an otherwise successful project to failure. In addition to undermining the commercial viability of a project, budget and schedule overruns can also impact the

shareholder values of publicly traded development companies. Despite knowing the consequences of poor budget and schedule management, performance problems like this are the norm in the Russian construction industry. In the wake of the real estate crisis that deeply changed the Russian construction industry, the need for improved governance is more pressing than ever. The days of record returns on investment have come to an end. In addition, increasingly competitive and stringent funding opportunities make it essential for construction projects to stay on budget and time. However, despite the need for effective governance systems in real estate projects, the root causes of poor performance have not been addressed and are typically left to the gut feeling of the project managers.

Performance problems in construction development projects are not unique to the Russian construction industry. A study in 1987 that investigated cost overruns in civil engineering projects across the world found that budget overruns typically vary from 30% to as high as 250%. Meanwhile, reported under runs were minimal. Another survey states that close to 40% of large engineering projects researched on a worldwide basis experienced serious performance problems ($985 million average cost)(Miller and Lessard, 2001). As a result, research was undertaken to identify the root causes of performance problems in construction projects across the globe.

Author B. Kagan Ceylan (Dr.Eng., MRICS), Manager, Construction Project Management Group, Ernst & Young (CIS) BV

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In the wake of the real estate crisis that deeply changed the Russian construction industry, the need for improved governance is more pressing than ever
Performance problems construction in Russia
Are some construction projects more likely to experience performance problems than others? If so, can they be identified and tackled early in the development cycle to prevent or minimize poor performance? In order to determine the root causes of widespread performance problems in the Russian construction industry, our Ernst & Young CIS Real Estate Advisory Services team undertook a study based on the input of practitioners from a range of construction projects. Our first objective was to identify the major determinants of success in construction projects at the macro level for budget and schedule performance the two most important criteria for both developers and contractors. Our second objective was to develop an indicator to predict the likelihood of budget and schedule overruns early in the development life cycle, if possible, prior to the beginning of construction; and to be able to identify those areas that need improvement for project success, again at the macro level. Our third objective was to gain a better understanding of the impact of the alignment of the owner and contractors at the micro level and provide some suggestions about the effect of this alignment on project performance. Learn more about some of the early results of our research into achieving these goals and the implications for the current construction market in Russia. Although these results are based on data collected from the Russian construction industry environment, the insights are relevant to other countries as many characteristics of construction projects are similar across the globe. an integrated combination wherein the formulation and implementation are considered to be interactive elements. (Ventkatraman and Camillus, 1984). The starting point of our study was to apply these basic concepts of organization and management science and project management theory (Duncan, 1972; Diekman and Girard, 1995; Lawrence and Lorsch, 1967) to the local market conditions. Using this knowledge together with input from construction project managers, we tried to identify the set of potential performance determinants that have the greatest impact on project performance in the Russian construction industry. Based on the result of our review, we believe that construction project performance is determined by the following key factors: The external project environment (e.g., regulatory, economic, cultural, social factors). Interaction of the project organizations (e.g., the owner and the contractors project team) with this external project environment. Strengths and weaknesses of the project organization i.e., factors that constitute the project teams internal environment (e.g., experience and educational level, financial strength of the owner and the contractor, effective business practices).

Determinants of project performance


A construction project starts with a business case for which experts design a solution, define a work package and select contractors using a bidding processes. The selection of an appropriate strategy is an integral part of this process to maximize the project value in terms of cost, time and quality, while achieving the owners business goals. The scope of the selected strategy also reflects the extent of the owners and contractors planned and present interactions within the project environment. Environment-strategy-performance alignment requires that an organizations performance consists of both internal and external links. The research on the subject also identifies key perspectives of strategic alignment between environment and performance, based on whether the elements to be aligned are: (a) internal (i.e., the fit between strategy and organizational structure where the focus is on the implementation of strategy); (b) external (i.e., the fit between the firms strategy and its environment, where the nucleus is strategy formulation); or (c)

Determinants of project performance

Characteristics of the project (e.g., design and construction complexity). Strengths and weaknesses of the internal operating procedures of the project organization (e.g., dispute resolution processes). The effectiveness and completeness of the planning process prior to the construction (e.g., technical, financial, organizational, operational). In order to establish the correlation between the project performance and the determinants of each key factor identified (see Figure 1), we conducted a survey measuring the impact of each determinant on a scale of 1 to 5. The correlations between the determinants and the degree of schedule and budget overruns were then measured as shown below, identifying the determinants that were linked to poor project performance. Our survey was partially based on the existing past research in this area (Diekmann and Girard, 1995) with extensions based on organizational and strategic management theories.

Figure 1. Performance determinant categories identied within the strategic management framework
External environment Complexity of project Contractual, design, construction, pioneer project Site limitations Remoteness Suppliers Ination Labor and equipment availability Labor and equipment productivity Internal environment (both owner and contractor) Capable management Experience with type of project Experience/competence Interpersonal skills Success in past projects Educational and technological background Lack of nancial resources

Project execution Strategy development process Input from all groups involved Financial planning Permits and regulations Scope denition Contract preparation Realistic obligations Risk identication/allocation Adequacy of technical specications/plans

Implementation organizational structure and systems Motivation (reward structure) Operating procedures Dispute resolution processes Responsibility structures

Performance Budget overruns Schedule overruns Variations experienced in project targets


Source: Ernst & Young analysis

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Correlations of determinants and budget and schedule overruns


External project environment The only budget performance determinant from the external project environment category appeared to be the complexity due to the number of parties involved in the projects execution (see Figure 2). Understandably, the number of parties (regulatory bodies, agencies, organizations assigned for specific responsibilities, and various independent consultants) appears to impact negatively the project performance. The complex regulatory environment in the Russian construction industry appears to be one of the main factors complicating these relationships. Figure 2. Effect of complexity due to number of parties involved in the project on project budget and schedule overruns
Effect of complexity due to number of parties involved on budget overrun Very high number of parties 5

Quite high number of parties Moderately high number of parties Somewhat high number of parties Few parties 0% 10% 20% 30% 40% 50% 60%

Budget overrun in % Effect of complexity due to number of parties involved on schedule overrun Very high number of parties 5

Quite high number of parties Moderately high number of parties Somewhat high number of parties Few parties 0% 10% 20% 30% 40% 50% 60%

Schedule overrun in %
Source: Ernst & Young analysis

Determinants of project performance

Project planning Our classification indicated that the highest number of significant performance determinants was related to project planning and pre-project preparation activities. The project planning activities that most impacted budget overruns were the following: Adequacy of scope definition (see Figure 3) Soundness of technical plans and specifications (see Figure 4) Definition of realistic obligations for the parties (see Figure 5) Establishing realistic obligations to the parties prior to project execution (see Figure 5)

Figure 3. Correlation between scope denition and budget and schedule overruns
Effect of scope denition on budget overrun Poorly dened Relatively dened 1 2 3

Moderately dened

Well dened

Best dened 0% 10% 20% 30% 40% 50% 60%

Budget overrun in % Effect of scope denition on schedule overrun Least dened Relatively dened 1 2 3

Moderately dened

Well dened

Best dened 0% 10% 20% 30% 40% 50% 60%

Schedule overrun in %
Source: Ernst & Young analysis

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Figure 4. Correlation between adequacy of technical plans/specs and budget and schedule overruns
Effect of adequacy of technical plans/specs on budget overrun Poorly developed, reviewed, complete and clear Somewhat developed, reviewed, complete and clear Moderately developed, reviewed, complete and clear
5 2 3 4

Quite developed, reviewed, complete and clear

Highly developed, reviewed, complete and clear 0% 10% 20% 30% 40% 50% 60%

Budget overrun in % Effect of adequacy of technical plans/specs on schedule overrun Poorly developed, reviewed, complete and clear Somewhat developed, reviewed, complete and clear Moderately developed, reviewed, complete and clear Quite developed, reviewed, complete and clear
2 5 3 1 4

Highly developed, reviewed, complete and clear

0%

10%

20%

30%

40%

50% 60%

Schedule overrun in %
Source: Ernst & Young analysis

Determinants of project performance

Figure 5. Correlation between risk identication/allocation and budget and schedule overruns
Effect of risk identication/allocation on budget overrun Poorly dened and allocated 1

Somewhat dened and allocated Moderately dened and allocated Well dened and allocated

4 Very effectively dened and allocated 0% 10% 20% 30% 40% 50% 60% 5

Budget overrun in % Effect of risk identication/allocation on schedule overrun Poorly dened and allocated 1 Somewhat dened and allocated Moderately dened and allocated Well dened and allocated 5 Very effectively dened and allocated 0% 20% 40% 60% 4 3 2

Schedule overrun in %
Source: Ernst & Young analysis

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Project execution In addition to project planning, the project execution category also contained a high number of determinants. These included: The responsibility structures of the owner and the contractor (see Figure 6) Effectiveness of operating procedures (see Figure 7) Reward structures (motivation) within the project teams Effectiveness of formal dispute resolution systems (see Figure 8)

Figure 6. Correlation between owners/contractors responsibility structures and budget and schedule overruns
Effect of owner's/contractor's responsibility structures on budget overrun Owner's/contractor's responsibility structure ineffective Owner's/contractor's responsibility structure somewhat effective

Owner's/contractor's responsibility structure moderately effective

Owner's/contractor's responsibility structure quite effective Owner's/contractor's responsibility structure highly effective 0% 10% 20% 30% 40% 50% 60%

Budget overrun in % Effect of effectiveness of owner's/contractor's responsibility structures on schedule overrun Owner's/contractor's responsibility structure ineffective Owner's/contractor's responsibility structure somewhat effective Owner's/contractor's responsibility structure moderately effective 5 3 4

Owner's/contractor's responsibility structure quite effective

Owner's/contractor's responsibility structure highly effective 0% 10% 20% 30% 40% 50% 60%

Schedule overrun in % Source: Ernst & Young analysis

Determinants of project performance

Figure 7. Correlation between operating procedures and budget and schedule overruns
Effect of operating procedures on budget overrun Ineffective procedures on payments, project controls, submittals, communication, etc. Somewhat effective procedures on payments, project controls, submittals, communication, etc. Moderately effective procedures on payments, project controls, submittals, communication, etc. Quite effective procedures on payments, project controls, submittals, communication, etc. Effective procedures on payments, project controls, submittals, communication, etc. 0% 10% 20% 30% 40% 50% 60% 5 1 2 3 4

Budget overrun in % Effect of effectiveness of operating procedures on schedule overrun Ineffective procedures on payments, project controls, submittals, communication, etc. Somewhat effective procedures on payments, project controls, submittals, communication, etc. Moderately effective procedures on payments, project controls, submittals, communication, etc.

3 2

Quite effective procedures on payments, project controls, submittals, communication, etc.

Effective procedures on payments, project controls, submittals, communication, etc. 0% 10% 20% 30% 40% 50% 60%

Schedule overrun in % Source: Ernst & Young analysis

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Figure 8. Correlation between formal dispute resolution processes and budget and schedule overruns
Effect of presence of formal dispute resolution processes on budget overrun Poorly dened contractual resolution processes Contractual resolution processes somewhat dened Moderately dened contractual resolution processes 5 3 Above average contractual resolution processes Effective contractual resolution processes 0% 10% 20% 30% 40% 50% 60% 1 2 4

Budget overrun in % Effect of presence of formal dispute resolution processes on schedule overrun Poorly dened contractual resolution processes Contractual resolution processes somewhat dened

3 Above average contractual resolution processes Effective contractual resolution processes 0% 10% 20% 30% 40% 50% 60% 1 2

Schedule overrun in % Source: Ernst & Young analysis

Determinants of project performance

Owner-contractor alignment and the impact on potential for project disputes


While the framework analyzes the relationship of each performance determinant within the project execution lifecycle, it lumps the owner and contractor teams into one project organization and does not take into account the possible differences between the owner and the contractor. In order to investigate the potential impact of owner-contractor alignment on the project performance, we canvassed the opinions of the owner and contractor representatives in one of the industrial projects we surveyed on the same determinants. Using this information, we first extended our analysis by applying a well known dispute prediction model (Dispute Performance Index DPI) to determine whether a project is prone to disputes (Diekmann and Girard, 1995). We further investigated the possible reasons for the poor project performance, including the likelihood of project disputes based on the actual data collected. The DPI predicts construction project performance and its sensitivity to disputes on a scale from 0% to 100% (see Figure 9). The higher the value of DPI, the less likely are contract disputes. For example, based on past construction project performance, DPI estimates higher than 80% have a 70% chance of avoiding disputes. On the other hand, projects whose DPI is less than 20 have only a 6% chance of experiencing good dispute performance. The scale of the DIP showing the scores and the project performance can also been seen. The project specific DPI is estimated as a statistical result from the series of questions, which were covered in the survey.

Figure 9. DPI predictions vs. project performance 100% % likelihood of poor project performance 80% 46 60% 40% 20% 0% 0-20 20 -40 40 -60 DPI score Good
Source: Ernst & Young analysis

5 38 55 38 44 70

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49 40 24 23 7 60 -80 7 80 -100

Average

Poor

The DPI of the case study project was calculated as 11% based on the average values of the responses to each question. The scores in each category are shown below together with a sample of good project scores for comparison purposes (see Table 1). The DPI of 11% puts the subject in the lowest category for this type

survey and indicates there is some 48% chance that the parties will experience more disputes than a project that scores average on this scale. Disputes are defined as any contract question or controversy that must be settled beyond the job site management staff.

Table 1. Dispute Performance Index calculated for case study project Individual evaluation factor Owner Management and organization Contractor management and organization Project complexity Project size Financial planning Project scope definition Risk allocation Contract obligations DPI % Case study project score 3.8 3.6 4.5 2.0 3.5 3.2 4.2 4.2 11% Sample good project score 4.8 5.0 3.9 4.4 4.3 5.0 4.6 5.0 95%

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The 11% DPI calculated based on the responses obtained from the owner and the contractor in our sample case eventually proved to be an accurate prediction. Following our assessment, the owner and contractor canceled the construction contract, although the dispute was eventually resolved without litigation. As may be expected, this outcome was also accompanied by relatively poor project performance in terms of schedule and budget overruns. The survey also revealed striking observations about the poor alignment of the owner and contractor and potential impact on the project performance. Both of them significantly disagreed on various important aspects of the project (see Figure 10), covering each group of determinants and the project execution lifecycle. It appears that, in this case, the poor alignment of the project strategy, structure and environment was amplified by the equally poor alignment between the owner and contractor.

Figure 10. Owner-contractor divergence in opinion on some key determinants of the project peformance
Complexity of project due to number of parties involved Construction complexity due to design Pioneer project (new technology or method, which have never been construction or used before) Availability of capable craftsmen/subs Productivity of labor Regulatory control over the project Experience and competence level of owners project individuals Input from all groups involved during preconstruction planning Financial planning (level of experience and effort of nancial planners and adequacy of nancial plan) Realistic obligations (practicality of contractual obligations such as schedule, budget and quality obligations) Risk identication /allocation (to ensure risks are assigned to the party with the best ability to deal with it) Formal dispute resolution processes (how contract spells out formal dispute resolution processes) Operating procedures (payment, schedule updating, submittal, meeting and communication procedures) Effectiveness of owners responsibility structure Team building
Low Contractor Contractor Contractor Contractor Contractor Contractor Contractor Contractor Contractor Contractor Contractor Contractor Contracto r Contractor Contractor Source: Ernst & Young analysis Owner Owner Owner Owner Owner Owner Owner Owner Owner Owner Owner Owner High Owner Owner Owner

While the need for effective alignment between the owner and the contractor is true for all markets, the Russian market that is typically characterized by high levels of uncertainty and risk

Determinants of project performance

Conclusions on performance determinants Russian construction industry


The preliminary findings from our surveys indicate the need to start right, in order to finish right in Russian construction development projects. It is worth noting that the majority of significant performance determinants were accumulated in the project planning and execution categories. The poor planning aspects that affect project performance the most include: inadequate definition of scope; lack of having technical plans and specifications prior to the start of construction; and insufficient identification of project risks and allocation of obligations among the parties. These results indicate that those projects that experienced performance problems did not start with the appropriate pre-project plans, both from the technical and organizational perspectives. Similarly, the relatively high concentration of significant determinants in the project execution category (effectiveness of responsibility structures, operating procedures, reward structures and dispute resolution processes) indicates that project teams lack the necessary execution mechanisms and governance systems, which adversely impacts project performance.

When the impact on budget performance was reviewed, the overruns were relatively constrained at the range of 30% for the worst performing project. This may be due to the fact that most construction projects are executed on a lump-sum basis and, unlike schedules, contract budgets can be contained more easily using a variety of means, such as: reduced quality of works; optimization of construction operations; and reduced profit margins of contractors. The impact of the determinants of schedule overruns was much higher and typically reached or exceeded 60% of the initially planned project durations. This implies that significant amounts of costs are incurred indirectly through lost revenues, increased overheads and possibly disputes and other inefficiencies between the owners and the contractors as a result of such long schedule delays. In a market where projects are typically fast-tracked with negligible frontend preparation, contracts are often issued with minimal concept design documentation approval. Consequently, project planning and execution mechanisms typically need to be stepped up afterwards in the form of fire-fighting. This mode of operation suggests that there needs to be a paradigm shift in the planning and execution phases. The apparent advantages of early commencement of construction development projects

(e.g., driven by the assumed shorter times to market) should be much more carefully evaluated; possibly with quantitative and structured methods as opposed to relying on the decision makers gut feeling as was the case during the boom times. The potential costs of the current approach are generally both indirect and significant. This need for improved project preparation and control is more urgent than ever in the post-crisis environment that is increasingly competitive and subject to more stringent regulation, and requires improved project development governance systems for the real estate development investments to be viable. Finally, our investigations also revealed that poor alignment between the owner and the contractor can further intensify project performance problems. While the need for effective alignment between the owner and the contractor is true for all markets, the Russian market that is typically characterized by high levels of uncertainty and risk. The poor alignment of the parties to the project has the effect of polarizing them. In turn, this creates a divergence of opinion as to the project goals and makes the parties more protective of their own interests in the face of challenges that could be addressed better through cooperation saving the overall project from failure.

Acknowledgment: This research was supported by the thought leadership program of Transaction Real Estate Advisory (TREAS) of Ernst & Youngs Moscow office. TREAS Moscow is the leading advisor in the CIS countries providing professional services in the areas of construction project management, real estate valuation, hospitality and real estate development advisory with a team of 56 specialists.

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