Economic and Social Factors
Even with good initial estimates and few changes, cost escalation occurs because of
social and economic forces beyond the contractor ’ s or user ’ s influence. Labor strikes, legal
action by interest groups, trade embargoes, and materials shortages all serve to stifle progress
and increase costs, but can neither be precisely anticipated nor factored in to plans and
budgets. Whenever project work is suspended or interrupted, administrative and overhead
costs continue to mount, interest and leasing expenses continue to accrue on borrowed capital
and equipment, and the date when payback begins and profit is earned is set back. Rarely can such
problems be anticipated and their impacts incorporated into the contingency fund. One economic
factor that has major influence on cost escalation and project profitability is inflation.4 The contractor
might try to offset increases from inflation by inflating the price of the project, although the actions
of competitors or federal restrictions on price increases often preclude doing that. Some protection
from inflation may be gained by including clauses in the contract that allow increases in wage or
material costs to be appended to the contract price, 5 but the protection may be limited. Inflation is
not one dimensional; it varies depending on the labor, materials, and equipment employed, the
geographical region, and the country.
Subcontractors, suppliers, and clients use different kinds of contracts that have different
inflation protection clauses and that might or might not be advantageous to other parties in the
project. Inflation also causes cash flow difficulties. Even when a contract includes an inflation clause,
payment for inflation-related costs is tied to the publication of inflation indices, which always lags
behind inflation. Although contractors pay immediately for the effects of inflation, not until later are
they reimbursed for these effects. Trend analysis of inflation in the industry and economy can improve
the accuracy of cost estimates. In long-term projects especially, wage rates should be projected to
forecast what they will be at the time they must be paid; this is done by starting with best estimates
of labor hours and wage costs in current dollars, then applying inflation rates over the project ’ s
length. In international projects, costs escalate also because of changes in exchange rates . When the
costs are incurred in one currency but paid for in another, a change in the exchange rate will cause
the relative values of costs and payments to change, resulting in an escalation of cost or price. This
topic is considered further in Chapter 18. Initial cost estimates are based upon prices at the time of
estimating. After that, whenever actual costs are compared with initial estimates, inflation
adjustments must be included so there remains a common basis upon which to identify variances and
take corrective action.
LIFE CYCLE COSTS
Life cycle costs (LCC) represent all the costs of a system, facility, or product throughout its full
cradle-to-grave life cycle. The concept originated in military procurement when it was realized that
product development represents but the tip of the cost iceberg—that the cost to operate (e.g., fuel
consumption) and maintain (e.g., parts replacement) a system or product is usually far greater.
Whereas the emphasis in this chapter is on project costs , i.e., costs incurred during the project life
cycle phases of Definition and Execution, LCC include the reminder of the systems development
cycle—the Operations phase and eventual disposal of the end-item—and, sometimes, for the
Conception phase too (initiation and feasibility). Anticipating the LCC is necessary because costs
influence many decisions. For example, suppose three contractors submit proposals to build a plant,
and each proposal contains not only the plant acquisition (construction) price but also the plant ’ s
expected operating costs. If the bids are similar in terms of construction costs and plant features, the
bid with the lowest operating costs will likely win. The LCC similarly affects decisions regarding
research and development; indeed, the initial feasibility study of a project should take into account all
the costs for acquisition, operation, maintenance, and disposal of the system, product, or facility. For
example, most US aerospace manufacturers in the 1970s were hesitant to develop a supersonic
commercial aircraft because of cost and environmental impact concerns. Costs to develop and
produce the aircraft were projected to be high, as were costs for operation and maintenance. At issue
were whether enough people would pay the high ticket prices necessary for the airlines to make a
profit, and whether enough airlines would purchase the jet for the manufacturers to make money.
Ultimately, many felt the answer was no on both counts.
Congress canceled subsidies for developing the aircraft, and the program dissolved. Meantime
the Europeans decided differently and went on to manufacture the Concorde, only 14 of which went
into service. Concordes flew for nearly 27 years and the last one was retired in 2003. The LCC was
never recouped, and had not the governments of Great Britain and France provided subsidies, the
airlines and manufacturers would have lost money. Key decisions affecting the operation,
maintenance, and disposal of a system are made early in the project life cycle—during Conception and
Definition. When a product is conceived and designed so as to have a relatively low operating cost, it
becomes more appealing—even if its development cost and purchase price are higher. For example,
the high cost of developing more fuel-efficient vehicles might require those vehicles to be priced
higher than other less efficient vehicles, but customers will readily pay the price if they know that over
the life of the vehicle they will recoup the price excess through fuel savings and lower pollution. Of
course, estimating the LCC always involves assumptions about technology, market, and product
demand, and relies on historical costs of similar systems and projects; nonetheless, it is a sensible way
to approach projects, especially when a choice exists among alternative designs or proposals
