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Fleming is a private consultant in projectmanagement, Tustin, Calif. Koppelman is the co-founder and President of Primavera Systems, Inc.,Bala Cynwyd, Pa.

R I S K M A N A G E M E N T

Earned Value ManagementMitigating the Risks Associated withConstruction ProjectsQ U E N T I N W . F L E M I N G • J O E L M . K O P P E L M A N

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Everyone knows certain “truths”about Earned Value management.Such knowledge is often basedon what we may have heard oth-ers say about the technique. For

example:

“Earned Value is useful only on large gov-ernment-funded contracts.” • “EarnedValue is useful only on cost-reimbursable-type projects.” • “Earned Value has no util-ity in the management of lump-sum or firmfixed-price work.” • “Earned Value doesnothing for construction projects.”

Respectfully, we take exception to these“truths” and would like to present a casefor the employment of a simple form ofEarned Value on all projects—large orsmall, cost-type and fixed-price—it re-ally doesn’t matter. The basic utility ofEarned Value is to contain the cost risksassociated with projects. Bad news nevergets better with time. The earlier youknow that you have a problem on yourproject, the better chance you will haveto mitigate that problem.

While we believe you can, and perhapsshould employ some minimal form ofEarned Value on any project, as a wayof facilitating this discussion we willcover using Earned Value on a specifictype of project—a construction project.We will discuss the use of Earned Valueon construction projects while em-ploying either the Design-Bid-Build con-cept, or the Design-Build approach. Sur-prisingly, much of the basic Earned Valuedata is already available on most con-struction jobs. We will also make six

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specific recommendations for usingEarned Value management to mitigateproject risks.

What is Earned ValueManagement?An interesting phenomenon exists inthe construction industry. The industryprobably uses parts of Earned Valuemanagement about as well as any in-dustry. But, what makes it interesting is

that in construction work, practitionersrarely use the term “Earned Value.”Often, they do not even realize that theyare in fact using a form of Earned Value.Anytime the construction cost engineersput a project baseline plan in place, thisis Earned Value in its purest form. Butask cost engineers if they use EarnedValue management and often you willget a blank stare.

A typical project baseline plan wouldconsist of: 1) a detailed schedule con-taining all of the authorized work; 2)schedules containing the authorized re-sources to conduct the work; and 3)payments by the cost engineer to con-tractors based on their physical accom-plished work, together with the origi-nal authorized budget for the work.

Earned Value management is a tech-nique that can be applied, at least inpart, to the management of all capitalprojects, in any industry, while em-ploying any contracting approach. Theemployment of Earned Value requiresa three-dimensional measurement ofproject performance, ideally from asearly as possible—perhaps as early as15 percent complete, up to 100 percentfinal completion. However, two of thethree dimensions of Earned Value—thebaseline plan and the physical perfor-mance measurement—will apply to allcapital projects, in any industry, usingany contracting method.

Point: People sometimes get “hung up”on precise terminology. The ardent pro-ponents of Earned Value will often usespecific terms with exact meanings.Most construction managers may notuse the Earned Value terms “PlannedValue” or even “Earned Value,” but theprocess they go through to establishtheir baseline plans and then to mea-sure performance against their plans isexactly the same. Only the jargon maybe different.

To understand the concept, we must un-derstand the following three dimensionsof Earned Value:

• Planned Value, which consists of theauthorized work, along with the au-

thorized budget, within the autho-rized time-frame, which in total formsthe project baseline.

• Earned Value, which is the authorizedwork that has been completed, plusthe original budget for the work.

• Actual Costs, which are the actual costsincurred to convert the Planned Valueinto the Earned Value.

Both the Planned Value and the EarnedValue dimensions will apply to all con-struction projects. Only Actual Costsare sometimes unknown in construc-tion, particularly on fixed-price or lump-sum jobs. In the discussion coveringprogress payments later in this article,we offer a few recommendations to helpbetter manage the process.

What is the Design-Bid-BuildConcept (or Engineer-Procure-Construct Method)?The more traditional, established ap-proach to construction is called the De-sign-Bid-Build concept, or, sometimesalso referred to as the Engineer-Procure-Construct method. This approach takesa new construction project and breaksit into three distinctive but sequentialphases:

• The complete design of the new item.• The execution of a competitive solic-

itation, bidding, and construction con-tract award process.

• The actual construction of the newfacility.

Today, construction work is most likelyaccomplished under the Design-Bid-Build approach.

To start Design-Bid-Build, a selection ismade of an architectural or design firmto capture the thoughts of the owner ofthe new project. Because this broad con-ceptual direction is often subject tochanges as the design solidifies, suchwork is often (but not always) done ona soft or cost-reimbursable contract basis.The owners often start out by describingwhat they envision as a final product, butwill often change directions to the ar-chitect as the design evolves. The designfirm, taking directions from the owner,then completes the definition up to what

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is described as the 100 percent completedesign point.

Next, the owner will take the final 100percent construction design and, oftenwith the professional assistance of oth-ers—perhaps a project manager, some-times a construction manager, or some-times both—will prepare a solicitationpackage to request firm quotes from mul-tiple construction firms. The final designwill take the form of drawings and spec-ifications sufficient to the extent that anexperienced independent constructor canbid on a new job with precision and con-fidence. This is the bid or competitionphase of the project, which will often takeseveral months to complete, dependingon the size and complexity of the pro-ject. Often, but not always, the originaldesign firm is also retained and used inconducting the process.

Once a contractor is selected, a contractis awarded to the successful constructionfirm—quite often to the lowest respon-sible bidding firm. The physical con-struction work will be started. As dis-cussed earlier, once final constructionwork begins, a common practice is to re-tain the original design firm to assist theproject manager, construction manager,or both with the interpretation of designrequirements. Typically, design contractswill be cost-type, while the constructionwork is most likely lump-sum. But thereare exceptions.

From the start of design through the bid-ding and selection process through con-struction, the final product will be builtand delivered; and the team will then bedismantled and sent on to the next pro-ject. Sometimes, however, open itemscalled construction claims will remain tobe settled. These open items will even-tually be settled and the project com-pleted.

Under Design-Bid-Build, the ultimateconstruction contractor is not a part ofthe original design team. Thus, the de-signers will not gain valuable input fromthe people who will do the final con-struction work and will be spending themajority (perhaps more than 90 percent)of the project dollars. Some believe this

is an important opportunity that is need-lessly lost.

One last important point on the three-phased Design-Bid-Build process. Somemaintain it contains opportunities forconstruction claims to proliferate. Thefinal settlement of the costs of con-struction claims can easily exceed theoriginal costs of the design. Many own-ers suspect that the original 100 percentdesigns, completed without valuable in-puts from the physical constructors, maycontribute directly to constructionclaims.

Undoubtedly, the Design-Bid-Build ap-proach is the most popular approach inconstruction. But performing the workin three distinct sequential phases takestime. Hence, someone came up with theidea of a faster approach. Enter the “De-sign-Build” concept.

What is the Design-BuildConcept (or Design-ConstructMethod)?While the Design-Build concept hasbeen practiced in Europe since the 18th

century, only recently have most pro-ject owners accepted its broad use.Under the Design-Build concept, a sin-gle contractor assumes complete re-sponsibility for both completion of thefinal design and the resulting construc-tion effort. Hence, the final design ef-fort will have inputs from the ultimateconstructor.

The owner starts the process by autho-rizing what is called the “preliminarydesign” for the project. The owner willcontract with an independent designfirm to create a design definition suffi-cient to allow a Design-Build firm to bidon the total remaining effort, includingboth the final design work and con-struction work.

Just what constitutes a preliminary de-sign will vary from project to project.But the preliminary design is typicallydescribed as representing the 20 to 35percent point in the design process.Some projects increase or decrease thesepercentage values, and the exact pointis an arbitrary one at best.

Once the designated preliminary designpoint is reached, the owner will typi-cally issue a formal Request for Quali-fications response from firms with ex-perience in Design-Build contracting.Prospective firms in Design-Build—oftenconstruction firms—will either com-plete the final design themselves or sub-contract outside for the completed de-sign. Or, many experienced Design-Build firms will employ some combi-nation of participation from designersand constructors. Most critical, how-ever, is the fact that the Design-Buildfirms have a proven track record in thistype of construction. The assumed sav-ings in both time and money to theowner come from assigning a singlepoint of responsibility with the use ofDesign-Build.

An initial “big-list” of potential Design-Build contractors will be evaluated basedon their responses, and then reduceddown to a “short-list” of only qualifiedcontractors. From the short-list, theowner will solicit formal bids with a Re-quest for Proposal. The short-list of finalcontractors will represent perhaps onlythree or four contenders. Because thisfinal bidding process places a financialburden on the qualified prospective bid-ders, and to keep all of them in the bid-ding process, an accepted practiceemerging in some quarters is for theowner of the project to grant a small“honorarium” to the short-list of finalcontractors. Such honoraria simply de-fray some of the costs of bidding. Theowner will then make a final selection,awarding a single contract to a firm tocomplete the final design and performall of the construction effort on the pro-ject. Design-Build begins.

Proponents of Design-Build suggest thatthis approach provides substantial ben-efits to the owner. Among the describedadvantages are:

• A single point of responsibility forboth the final design work and theconstruction.

• A shortened time-table for overall pro-ject completion.

• Total project costs known at the out-set.

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• Higher quality. • Innovations in the construction

process, which are then incorporatedinto the final design.

Perhaps one of the most important ben-efits is the potential reduction of finalconstruction claims that have resultedfrom the “professional” differences ofopinion between the architects and de-signers vs. the constructors. If this pointis in fact true, claim reductions alonecould save considerably in the overallfinal costs to the owner.

One last point—the final Design-Buildcontract can take several contract forms,which will vary the risks to the owner.Three contract types are typically usedin Design-Build relationships:

• Fixed-Price/Lump-Sum• Cost-Reimbursable• Cost-Reimbursable with a Guaran-

teed Maximum Price.

Some owners will separate the designfrom the construction phases and use adifferent contract type for each phase—a cost-type for the design phase and alump-sum for the construction phase.Others will issue a single contract typefor both the design and construction ef-fort. Each of these three types carries itsown unique risks, which we cover laterin this article.

Monitoring and AnalyzingEarned Value Project MetricsUsing Earned Value metrics, any pro-ject can accurately monitor and mea-sure the performance of projects againsta firm baseline. Measurement will takeplace at regular intervals—certainlymonthly, but oftentimes weekly—where,as of a given point in time, the projectwill be determining: its Planned Value,its Earned Value, and the Actual Costsincurred. These three dimensions pro-vide a wealth of data reflecting the truehealth of projects.

Using the three dimensions of EarnedValue, the project management teamscan at all times monitor both the costand the schedule performance status oftheir projects.

To determine schedule status, we mustfirst determine the Earned Value mea-surement. Remember, Earned Value rep-resents two elements:

• The authorized work that has beencompleted.

• The original budget authorized to per-form the completed work.

To determine the schedule position, wemust take the Earned Value and sub-tract the Planned Value for the periodbeing measured. A negative value indi-cates that the project is behind in itsplanned schedule position.

Falling behind our planned schedule isone of the first indicators that the pro-ject is experiencing problems. However,the Earned Value schedule position isbest used in conjunction with criticalpath methodology. If the late tasks areon or near the critical path, they are im-portant. If the late tasks have lots of floator slack and low risk, they are only in-teresting and merely indicate that weare behind our original plan.

To determine our cost position, we mustalso start with our measured EarnedValue, but now we subtract the ActualCosts incurred to accomplish the EarnedValue. A negative value indicates thatwe are overrunning our costs. Cost over-runs are very serious in that they arerarely (if ever) subsequently recoveredby the project. Keep in mind that ourbest planning, scheduling, and budgetswill be front-loaded into the early phasesof the project. Thus, if we overrun theearly phases of the project, how can weexpect to recover the overrun in the lat-ter phases when the plans, schedules,and budgets are more uncertain?

Earned Value metric data can also beconverted into efficiency factors so wecan compare the efficiency rates of oneproject against all other projects in theorganization. Earned Value data are alsoexcellent for managing a portfolio ofprojects.

For example, if we take the Earned Valueachieved and divide it by the PlannedValue, we determine the schedule effi-

ciency factor, which we call the Sched-ule Performance Index (SPI). Any SPIvalue less than 1.0 indicates that we arerunning behind with our planned sched-ule. If our SPI is .84, this condition in-dicates that for every dollar of work weplanned to do, we only did 84 cents ofwork. The SPI provides a quantifiedmetric.

Most important, however, is the cost ef-ficiency we are achieving. Cost overrunsare more serious than falling behind ourplanned schedule, only because in theend the schedule will eventually be re-covered, whereas the cost overruns arerarely (if ever) fully recovered.

We determine our cost efficiency rate—the Cost Performance Index (CPI)—bydividing the Earned Value by ActualCosts incurred. Any resulting value lessthan 1.0 indicates that we are overrun-ning our costs. For example, a CPI of.82 indicates that for every dollar we in-curred in expenses, we only accom-plished 82 cents of value. Thus, we areoverrunning our costs.

The significance of the CPI metric is em-pirically proven (with over 700 DoDprojects studied) to stabilize at the 20percent completion point of a project.Also, the CPI metric becomes progres-sively more stable as the project con-tinues toward the 100 percent comple-tion point. Thus, the CPI can be usedto forecast the final project costs fromas early as 20 percent into the project.To forecast total final costs, the total au-thorized project budget (Budget at Com-pletion) is divided by the cumulativeCPI. Thus, you can continually moni-tor and forecast the final required coststo complete your project. It is as simpleas that.

Using Earned Value to MakeProgress Payments onConstruction ProjectsOwners of all projects (including con-struction projects) must take care tonever place themselves in a position ofoverpaying their suppliers for the workthey complete. Stated another way, thevery quickest way to increase the riskson any project is to overpay suppliers

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for their completed work. Cost-typearrangements have inherent risks be-cause some owners simply focus on theactual expenses incurred, without alsoclosely monitoring the actual work ac-complished for the monies spent.Earned Value management can help inthis process.

Likely, the best way to mitigate con-struction risks on fixed-price or lump-sum work is to accurately measure thevalue of the work completed, togetherwith the original budget authorized forthe completed work, and then only payfor the actual work accomplished, lessany withholds or retentions as may beallowed by the contract. Earned Valuemanagement can also help with thisprocess.

Payments on “Cost-Type” and“Fixed-Price-Type” ContractsToday, the two broad contractual envi-ronments prevalent throughout DoD arecost-type and fixed-price-type. Bothneed to be addressed separately—bothrepresent separate issues.

Cost-Type ContractsCost-type contracts are sometimes (per-haps often) used in construction pro-jects to cover the initial design work—both the preliminary and finaldesign—in both Design-Bid-Build andDesign-Build approaches. Additionally,on selected other projects that are con-sidered to be inherently high risk for theconstructor (for example, nuclear en-ergy construction), cost-type contractsare sometimes used for all phases—boththe design work and the constructioneffort.

Under a cost-reimbursable-type arrange-ment, the suppliers will be reimbursedeach month for their actual costs in-curred on the project, subject to theterms of their agreement. Payments offees are normally withheld until specificdeliverable objectives have been met.But all incurred costs (without fee) aresubmitted by the supplier to the owner,and are then paid by the owner. Some-times on cost-type arrangements, wherethe process is not watched closely, therecan be a wide disparity between the

physical work done and the dollarsspent. Thus, the risks to the owner es-calate. We offer four recommendationsto mitigate the risks with cost-type con-tracts. All owners on cost-reimbursable-type contracts should:

RECOMMENDATION NO. 1Require that the performing supplier(the designer or constructor) provide atime-phased “Schedule of Values” inwhich the sum of the line items will addup to the total contract value. A time-phased Schedule of Values provides theowner with a simple form of PlannedValue against which performancethroughout the life of the project maybe monitored and measured.

RECOMMENDATION NO. 2Each month, as the suppliers submittheir invoices reflecting the actual costsincurred, require that all contractors up-date their Schedule of Values reflectinga percent complete position, i.e., theEarned Value for the project. Thus, theowner of the project will have the meansto monitor performance by comparingthe Earned Value less the Planned Valueto determine schedule variance, and alsoEarned Value less Actual Costs to de-termine the cost variance.

RECOMMENDATION NO. 3Always monitor performance of boththe cumulative SPI and CPI to compareresults of one project to all other pro-jects in the enterprise.

RECOMMENDATION NO. 4Continuously forecast the likely finalcosts on the project using a simple butaccurate estimating technique (the totalproject budget divided by the cumula-tive CPI) to provide assurances that theproject will be completed within ac-ceptable cost risks to the owner. Unac-ceptable risks would be any forecastedfinal position that exceeds the owner’savailable funds, or penetrates the Guar-anteed Maximum Price.

Fixed-Price-Type orLump-Sum ContractsUnder a fixed-price-type arrangement,the suppliers are typically given progresspayments based on their demonstrated

percentage of work completed, togetherwith the authorized budget for the com-pleted work. Again—pure and simple—this is Earned Value at its finest, as typ-ically employed on most constructionprojects. One can easily establish theEarned Value baseline or Planned Valueusing one of two methods: “Schedule ofValues” or “Critical Path Method (CPM)Schedule.”

SCHEDULE OF VALUES

Just as we recommended for cost-typework, the Earned Value baseline, orPlanned Value can be created with useof a Schedule of Values,” which is time-phased. The Schedule of Values can beupdated monthly to reflect the measuredEarned Value and used to authorize pay-ments to the constructor.

CRITICAL PATH METHOD

(CPM) SCHEDULE

Another very effective method to es-tablish an Earned Value baseline wouldbe to require that the performing sup-plier create and submit a “Critical PathMethod (CPM) Schedule” with resourcesembedded into the CPM network—thesum of which must add up to 100 per-cent of the contract value. Assumingthat your schedule software package hasthe ability to freeze this baseline, youwill have in place the equivalent of aPlanned Value baseline. Payments tosuppliers will be made each monthbased on their reflected percentage com-pletion—their Earned Value. (Note thatthe resource-loaded CPM schedule willwork nicely on either cost-type or fixed-price work.)

Typically missing with fixed-price orlump-sum work, however, are the Ac-tual Costs related to the Earned Valuebeing measured. Without the ActualCosts related to the Earned Valueachieved, we lack the ability to deter-mine the cost performance efficiencyfactors—the CPIs—which are likely themost important metric in Earned Valuemanagement. However, there may be away to get the information needed tobring owner risks down to acceptablelevels, without invading the sacred costledgers of our performing fixed-pricesuppliers.

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Whenever performing suppliers accepta fixed-price job, they are often highlyreluctant (they adamantly refuse) to dis-close to the owner how much profit theyare making on a given job.

Question: Do we really care if our sup-pliers make a profit on our jobs, even abig profit? We don’t think so.

It’s only when suppliers start incurringa loss, particularly a big loss, that weshould really be concerned. The big-ger the loss, the more likelihood thesupplier may not complete the job. Tomitigate risks to the owners, we needto know about, and to quantify po-tential supplier losses as early as pos-sible.

RECOMMENDATION NO. 5Require that all fixed-price suppliers pro-vide a financial projection of their antic-ipated costs incurred, to accompany theirPlanned Value projections containedwithin either the time-phased Scheduleof Values or their resource-loaded CPMnetworks. Such costs-incurred forecastsshould typically resemble what is com-monly called an “S” shaped curve, orsometimes referred to as “one-half a bellshaped curve.” Such financial curves typ-ically will project a slow beginning, a fastacceleration in the middle, and then aslow close-down to completion. Unlessextenuating circumstances exist, all pro-ject expenditure profiles should resem-ble an “S” shaped curve. Anything otherthan an “S” curve might indicate that thecost projections may be front-loaded. Al-ways watch out for front-loaded projectbaselines.

RECOMMENDATION NO. 6As a condition to making monthly pay-ments to fixed-price suppliers, requirealso that the Chief Financial Officer(CFOs) for your suppliers “certify” eachmonth that they have not exceeded theirown financial forecast of costs incurred.However, if they have exceeded theirown forecasted values, require that theyalso disclose the amount of their costsincurred, so that you can compare it tothe Earned Value and quickly determinethe amount of loss the contractors areexperiencing.

By closely monitoring the relationshipbetween Earned Value and Actual Costsincurred, even on fixed-price jobs, own-ers may use these data to monitor sup-plier performance and take action earlyenough to mitigate the financial risks ofprojects. Although you may not elimi-nate such risks, possibly you may bringthem down to acceptable levels.

Making Our CaseFor this article, we have tried to makethe case for using at least a simple formof Earned Value to mitigate the costsrisks on all construction projects, eitherDesign-Bid-Build projects or Design-Build concepts. Most of the data forusing Earned Value is already in placeon most construction projects. Only theperformance efficiency factors and fore-casting methods are typically not gen-erated in construction work. But theycertainly could be.

We believe the six specific recommen-dations offered in this article could helpin this process. Likely, many projectmanagers may believe that they do not

need to have their performance moni-tored this closely, particularly when theyare performing under a fixed-price orlump-sum arrangement. However, therisks of cost increases (called overruns)and potential project failures ultimatelyrest with the project’s owner, and some-times also with the surety companiesunderwriting construction performancebonds. Owners and sureties may wellhave different thoughts on the benefitsof using Earned Value management tomonitor construction project perfor-mance.

In our opinion, Earned Value manage-ment should have an important placein the management of any type of con-struction project.

EEddiittoorr’’ss NNoottee:: The authors welcomequestions or comments on this article.Contact Fleming at quentinf@msn.com;Koppelman at JKoppelman@Primavera.com.

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