Three ways to avoid mega projects going way over budget

The headlines scream: Victoria’s ‘big build’ is facing huge budget blowouts.

The road system known as North East Link is running AU$10 billion over original estimates; the West Gate Tunnel, first quoted at AU$5.5 billion, is now AU$10.2 billion and counting. And as for the city Metro Tunnel – the State Government will now have to find at least another AU$1.36 billion.

To the average punter, the figures seem astronomical. To the experts, they are too.

We are routinely getting outcomes in Australia that are bottom of the class, and the lessons learnt about mega project delivery internationally aren’t being widely applied locally.

How can the next wave of mega projects in Australia, like the Suburban Rail Loop project in Victoria and the Olympic Games in Brisbane, avoid a similar fate?

Get the Board right

The first lesson is to get people, including those on the project boards, who have deep proven experience delivering mega projects.

In a classic example of what happens when you don’t, the Schott inquiry into Inland Rail – another mega project facing massive cost and time blowouts – begins with a pointed finding that “the Board and its Sub-Committee do not have adequate skills to oversee this project”.

There are many hurdles to getting this right. Too often appointments go to those with the right connections rather than the right skills. There is also limited industry training, research and forums targeted at improving these mega project delivery skills.

Fix the pricing game

One of the fastest ways to get mega project delivery teams working toward opposing goals is to use a lump-sum contract price, where the total cost to deliver the project is agreed upfront. It’s a common approach because of its attractiveness to those financing these projects.

But this approach kicks off a game that begins with fierce competition to win the project on price, and the temptation for the paying government is always to take the lowest price offered by the market.

For the winning contractor, this game then turns into finding ways to move that price up and avoid being blamed for anything going wrong.

What is best for the project goes out the window.

Ironically, a fixed-price contract actually makes the risk of cost overruns worse, because contractors focus on protecting their profit margin, while the government and other owners work to keep risks that do emerge on the contractors. All of which gets in the way of adopting strategies that deliver more reliable outcomes.

Minimising such commercial games was one of the reasons Major Road Projects Victoria adopted an Incentivised Target Cost Model when they developed their Project Delivery Approach in Victoria in 2020.

We are seeing a broader market shift toward collaborative contracts and incentivised target cost models where pricing risk can be managed differently.

Know that you can’t know everything

Projects of this scale and complexity are almost always over budget. This phenomenon has been called the Iron Law of mega projects by Bent Flyvbjerg, one of the world’s leading experts in this space.

The Iron Law is driven by the formidable political, financial, architectural, technological and, now, ecological factors behind projects of this scale. The odds are that less than one in ten mega projects will come in on budget.

Australia is a mature and sophisticated market capable of delivering complex mega projects but we continue to be unduly optimistic about our original project budgets and delivery strategies. And we naively continue to assume these projects can be fully scoped, understood and priced at the outset.

The reality is that projects with billion-dollar-plus budgets and five-plus-year construction times aren’t predictable and the strategies that deliver reliable outcomes for projects of this scale are very different to those that apply to smaller ones.

For example, the business case for North East Link in 2019 contains the ‘risk-adjusted (P90) capital expenditure costs’ for the project.

This means the original advisors had comprehensively simulated the risks and come up with a cost of the project that they were 90 per cent confident was the most probable cost outcome. It defies common sense to continue to use this methodology in this way, given that the historical odds tell us that we have only a 10 per cent chance of this being the outcome.

It also defies our lived reality, with the cost of the North East Link project increasing from AU$15.8 billion to AU$26.1 billion.

That extra AU$10 billion in five years – a blowout of 65 per cent – is not loose change readily found under the bed.

If the same AU$10 billion amount of cost growth happens over the next five years, that would take the total costs to AU$36.1 billion, an almost 130 per cent increase on the original budget.

This sounds bad, and it is, with similar tunnel projects globally having an average cost overrun of just 37 per cent.

Stop the blame game

We certainly won’t get to the top of the class delivering mega projects with demands for more ‘corporal punishment’ by the media, or with denials by politicians who naively insist projects won’t go over budget on their watch.

To successfully deliver projects of this size and scale, we need to study and apply the growing evidence around what does deliver best-in-class outcomes.

We should start by fixing our boards, contracts and cost estimating, and build experienced delivery teams who are working towards the same goal. We need to use approaches that have proven benefits on mega projects, including focusing and investing in the planning phase and looking for elements that can be made modular and scalable.

And expect cost overruns, but don’t accept massive blowouts.

Banner: Construction on the Melbourne Metro Tunnel / Getty Images