Navigating Quantum Calculations: Part 2 – Nailing Cost-Based Methods

July 3, 2023

This week we explore a more widely used cost-based method for calculating quantum in construction claims, as well as a productivity-based method. These methods are, respectively:

1. Discrete Damages/ Cost Variance Analysis Method; and
2. Earned Value Analysis.

Which of these methods is adopted will be dependent on various project specific factors and contractual mechanisms which govern what can be claimed, and how such claims should be developed.

Discrete Damages / Cost Variance Analysis Method

By applying a variation of the Delta Estimate and Modified Total Cost Methods, which we explored in the first instalment of the series, a more robust approach can be taken.  This technique is the Discrete Damage/Cost Variance Analysis Method (shown at Figure 1 [1]).

This method involves a comprehensive allocation of all project costs incurred, rather than focusing solely on specific segments of the cost analysis. It effectively distinguishes the cost growth attributed to bid errors, non-compensable costs, and compensable costs, thereby enhancing its credibility.

Contractually, this allows for a Contractor to make a claim which distinguishes between various factors which contribute to the total quantum. In doing so, this method can be tailored to ensure that the cost allocation process is aligned with the contractual basis of claim, and that noncompensable costs are clearly delineated from the quantum calculations.

To implement this method, the modified total cost approach is initially employed to determine the overall cost growth. Subsequently, the specific compensable costs associated with each claim problem are identified. The cost growth linked to each claim problem is then allocated to the corresponding cost account, ensuring that the cumulative sum of each claim does not exceed the total cost overrun for that account. This approach addresses this limitation of the Delta Estimate Method.

Practically speaking, this method can be adopted in situations where there are various issues arising in the context of a project, which correspondent to a total cost overrun. While the approach to calculating quantum will often be informed by relevant contractual provisions and allowances, this method benefits from the ability to identify and categorise compensable costs based on the issue which caused them. In doing so, this allows for a more detailed breakdown, especially in the context of global claims, and ensures the relevant contractual requirements around causation and specificity are complied with.

Seven-Step Method

The Discrete Damages/Cost Variance Analysis Method can be broken down into seven steps:

1. Divide each project work activity into the basic cost elements and identify the bid cost (budget) and actual cost for each cost element.
2. Identify the time frame of specific delays or disruptions so you can isolate when each problem or cost occurred.
3. Evaluate the contractor’s bid estimate to determine if it underestimated any cost elements of any activity.
4. Evaluate each activity and its cost elements for non-compensable cost items and reduce the actual cost for each activity by that non-compensable costs to get an adjusted value.
5. Assess each activity by time frame for the impact and cost overrun caused by each specific claim problem. Cost overruns outside the time frame in which the problem or its effect occurred are excluded from the compensable cost distribution and, therefore, are not compensable.
6. The cost/damage analysis components are totalled to determine the specific dollar amount of each requested claim.
7. The basis of the distribution of costs into the claim categories must be clearly communicated and supported with a cause-and-effect explanation to support the entitlement for cost recovery.

Strengths and Limitations

While the Discrete Damage/Cost Variance Analysis Method is the more comprehensive of the cost-based methods, certain limitations must be considered. Relevantly,  issues arise in cases involving several interrelated cause-and-affect relationships. Given this method is ordinarily suited for global claims, which attempt to capture the effects of various different issues,  isolating these causes and applying the method becomes more intricate and, in some instances, impossible. This is especially in circumstances where there are certain procedures or requirements around the nature of substantiating claims set out in the Contract, as the quantum will need to be developed in such a manner which allows for causation of each issue, and the associated link to the relevant quantum, to be substantiated.

Despite this, the method allows for a comprehensive explanation and justification of the total claim, which will ordinarily satisfy the contractual requirements surrounding evidencing the reasonableness of the quantum claimed. By evaluating and distributing all components of the cost records within the claim matrix, the total value of the claim can be explained, improving its credibility. The method enhances the burden of proof by establishing a clear link between entitlement and the amount of damages at the lowest level of detail in the cost records, an aspect which is typically required by certain contractual provisions. By separating cost growth resulting from bid errors, non-compensable problems and compensable problems, this method ensures the damages are accurately attributed, providing a more credible foundation for the claim.

Hence, in circumstances where various issues entitle a Contractor to claim, the adoption of the Discrete Damage/Cost Variance Analysis Method may function to:

1. ensure contractual requirements surrounding a basis to claim and entitlement are clearly linked to the quantum;
2. set out with a high degree of specificity the quantum calculations and the noncompensable costs which have been excluded; and
3. tailor the claim to include only those costs which the specific project Contract treats as compensable, for each individual issue experienced.

Earned Value Analysis

In contract, Earned Value refers to the value of completed work expressed in terms of the budget assigned to such work. This method is designed to estimate inefficiency and quantify the loss of productivity. Where there are various contractual claims that cannot be distinguished, which collectively impact overall productivity factors, this may present an alternative means to substantiate claims.

This method is especially effective when productivity data is not available for the Measured Mile Method, which we will explore next week. This technique is based on a realistic budget for the Contract and relies on a method for measuring the percentage acceptably completed.

In certain circumstances the Contract may lead parties to adopting an Earned Value approach, either by specific reference, or generally by way of the different factors which are accounted for when substantiating the quantum claimed.

The difference between the actual labour hours and the earned labour hours for the period of the impact are used to calculate the inefficiency experienced in either labour hours (Equation 1) or dollar terms (Equation 2).

The ‘earned labour hours’ can be determined by multiplying the physical units of work completed and the budget unit rates. However, it is cautioned that the budget used to generate the metrics is carefully reviewed and verified for reasonableness. Critical Path Method scheduling is a good source for obtaining earned value metrics and allows for like-time causation analysis.

How reliable is this method?

One of the main concerns is the credibility of this method. The percentage complete method employed may not provide as detailed and precise information as the method based on physical units of work completed. It must also be considered whether the original estimate used as a basis for the analysis can be substantiated. If the earned value analysis is based on an unreasonable budget, its validity is compromised.

In doing so, parties should consider the underpinning Contract and how the tender (and associated materials) are accounted for. Where there are certain warranties or obligations with respect to these documents, it may be necessary to consider the relevance in referring to them, and the potential issues which may be caused if there are challenges with substantiating the original estimate.

Further, parties should also consider if the Contract includes certain requirements surrounding causation and the ability to effectively link the issues to compensable issues. Where there are various issues impacting a project, and the impacts of such cannot be easily distinguished, it may prove difficult to align this approach, with the contractual claims regime which applies to the project.

However, a notable strength with this method is that it is advantageous in situations where detailed data collection is difficult, or simply, not available. By relying on a simplified approach, the analysis can still provide insights into project performance without the need for extensive data collection. This may save time and resources, making it a more efficient option in certain circumstances. Such circumstances may include where contractual claims are subject to certain time restrictions, which require the expedited preparation of claims.

Stay tuned for the final instalment of ‘Navigating Construction Claims’, where we will explore additional productivity-based methods for calculating quantum.

Lamont Project & Construction Lawyers

Contact: Peter Lamont or Kathryn Easton

Phone: (07) 3248 8500

Address: Suite 1, Level 1, 349 Coronation Drive, Milton Qld 4064

Postal Address: PO Box 1133, Milton Qld 4064

[1] Figure obtained from Long, R.J. (2023). ‘Discrete Damages and Cost Variance Analysis Method for Quantifying Damages in Construction Claims’. Long International.