2001 AACE International Transactions
CSC.01
Risk-Based Cost Control for Construction
William J. Bender, PE, and Bilal M. Ayyub, PE
he primary focus of this paper is to present a methodol-
T ogy to assist project managers and cost engineers to con-
trol cost when constructing a complex structure. Cost
control during the construction process is vital to
ensure the success of a project. The construction of a complex
structure is a major undertaking and typically has people specifi-
cally responsible for cost control. Most complex projects share the
common theme that they are fraught with risks and uncertainty
that can cause cost escalations. For example, Laufer and Howell
found that about 80 percent of all projects begin the construction
process with a high level of uncertainty [8]. Construction project
managers and cost engineers have a challenging task to build a
complex project that is on budget.
Construction and cost engineering professionals have long
recognized the need for improvements in the area of cost control
[6]. Managing costs includes estimating, scheduling, accumulat-
ing and analyzing cost data, and finally implementing measures
to correct a cost problem. There are several cost control tech-
niques that are used by the construction industry to varying
degrees. These are exception reporting, trend analysis, earned
value, range estimating, and forecast unit cost. Except for perhaps
earned value, these cost control techniques tend to focus on vari-
ances in line items once the cost overrun has been discovered.
What is needed is a cost control methodology that proactively
seeks out potential cost issues and provides project managers with
as much warning as possible before their occurrence.
RISK ANALYSIS
Risk analysis is identified as a major subset to project man-
agement [14]. However, its application appears limited within the
field of construction project management. It is limited in its wide-
spread use [2], and sometimes it is only applied to developing
schedules [11] or cost estimates [5]. The reasons for this limited
use are difficult to identify and quantify. McKim proposed that
risk analysis is viewed by construction cost engineers as an intim-
idating subject [10]. Blair states that the data required to apply risk
analysis is often expressed in linguistic terms and is difficult to
apply in a classic quantitative risk analysis [4]. An application of
fuzzy logic and set theory can be used as a solution to the later rea-
son [4, 13]. Al-Bahar and Crandall also point out that construction
professionals tend to use rules-of-thumb, and rely on intuition or
experience when dealing with risk [2]. What is needed is an
CSC.01.1
application of risk analysis to help project managers control cost
that is relatively simple to apply, can be used throughout the life
cycle of a construction project, accounts for the tendency of con-
struction professionals to apply risk in linguistic terms, and apply
their experience.
Risk Defined
The literature abounds with definitions of risk. Risk can be a
somewhat ambiguous term unless its definition and convention
are clearly stated. The concept of risk is used to assess and evalu-
ate uncertainties associated with an event. Risk can be measured
as a pair of the probability of occurrence (likelihood) of an event
and the consequences (outcomes) associated with the event’s
occurrence. This pairing is not a mathematical operation, a scalar
or vector quantity, but a matching of an event’s likelihood of
occurrence with the expected outcome. The generally accepted
expression for risk is shown in equation 1 [7].
Risk º [(P1 , C1 )(
, P2 , C 2 ),..., (Px , C x )]
(equation 1)
In this equation, Px is the occurrence probability of event x,
and Cx is the occurrence consequences or outcomes of event x.
The consequences of a risk event in the project management field
will most likely be in terms of dollars. Risk is sometimes thought
as the potential for harm. In a project management context and as
defined in this paper, risk is thought of as being concerned with
opportunities or potential gain as well as negative consequences.
This broader risk definition is known as risk engineering [15].
There is a consensus within the technical community that a
comprehensive risk analysis consists of risk assessment, risk man-
agement, and risk communication [12]. Risk assessment is the
process of identifying and evaluating areas of risk. Risk manage-
ment is the act or practice of dealing with or controlling this risk.
Risks can be managed based on the information provided from
the risk assessment to determine risk acceptability and using deci-
sion analysis to make risk informed decisions for control and mit-
igation purposes. Risk communication is the process of docu-
menting and exchanging information about the results of risk
studies to various interested parties.
 2001 AACE International Transactions
Risk Assessment
Risk assessment is a technical and scientific process by which
the risk of given situations for a system are modeled and quanti-
fied. Risk assessment provides qualitative and quantitative data to Lines of
decision-makers for later use in risk management. Risk assessment Constant Risk
for construction projects can be performed by comparing the
resource requirements needed to build the projects to the existing
industrial capacity and by performing simulations of the construc-
Increasing Risk
tion processes. These techniques highlight the critical cost areas
and opportunities for savings. When data does not exist or is

Likelihood
unavailable, a construction risk assessment can be made in quali-
tative terms. Where data exists or can be obtained, the risk assess- Curved Line of
ment is quantitative. The risk assessment then considers devia- Constant Risk
tions from these construction scenarios that can lead to undesir-
able or positive consequences. The consequences can be
described in terms of adverse or positive effects on a project’s cost,
schedule, safety, or technical performance.
Qualitative risk analysis uses expert opinion to evaluate the
probability and consequence of an event’s occurrence. Safety
review/audit, checklist, what-if, hazard and operability study Consequence
(HAZOP), preliminary hazard analysis, risk assessment matrix
Figure 1—Risk Profile and Levels of Risk
tables, analytical hierarchy process, consequence assessment and
cause consequence diagrams, expected monetary value using the where DCost is the monetary amount required to reduce risk and
Delphi technique, and influence diagrams are normally consid- DRisk is the level of risk reduction.
ered qualitative techniques. Quantitative analysis relies on statisti- An integral part of risk management is the use of decision
cal methods and databases that determine the probability and analysis. Project management and engineering are professions
consequence of an event. Simulation, failure modes and effects that require decisions to be made for the management of cost,
analysis, fault tree analysis, event tree analysis, success tree, acci- schedule technical, and safety risks. Most decision analysis tech-
dent progression and frequency analysis, common cause scenar- niques have the following steps or phases: identify the problem
ios, sensitivity factors, fuzzy stochastic applications, risk premium, and objectives, develop alternatives, evaluate the alternatives, and
expected monetary value and expected net present value, risk implement the best alternative [3]. In a risk-based decision analy-
adjusted rate of return, and stochastic dominance are generally sis, these steps should include the uncertainties associated with
considered quantitative risk assessment techniques. the data or alternatives. Four possible decision analysis methods
that can be used in a risk-based decision analysis methodology are
decision trees, goal trees, the analytic hierarchy process, and risk-
Risk Management based net present value.
Risk management is the process by which system operators,
project managers, and owners make decisions, changes, and
choose different system configurations based on the data generat- RISK-BASED COST CONTROL
ed in the risk assessment. Risk management is also dynamic as
new information about risk events becomes available managers A cost control technique that anticipates potential cost issues
should adjust accordingly. by using risk analysis and simulation techniques to highlight
In order to make decisions based on risk, a level of acceptable
potential areas prone to cost escalation is presented. This risk
risk must be determined. A risk profile diagram is shown in figure
analysis is also used to highlight areas where cost savings or a com-
1, lines of constant risk show that risk increases as the likelihood
petitive advantage may be gained. The risk analysis techniques
and/or consequence of a risk event increases. Figure 1 also shows
employed are a dynamic process, constantly updated, as new
that when considering risk acceptance, curves that show a high information becomes available. Risk analysis information, along
consequence with an extremely low likelihood, and vice versa, with cost forecasting tools, is combined to anticipate a project’s
may be used to show acceptable risk. Management should deter- cost problems and completion costs.
mine risk acceptance through a systematic process that may be The presented methodology is applied in the planning and
project specific, based on general corporate or government guide-
execution phase of a project as illustrated in figure 2. Risk meth-
lines. Risk acceptance can also be determined by the cost effec-ods are used to help establish cost and schedule targets in the
tiveness of risk reduction or opportunity gained. This cost effec-
planning phase. A project’s costs are a function of schedule, and
tiveness is calculated as the integration of cost and schedule is an important part of the
methodology. In the execution phase, risk methods are applied to
DRisk help managers control projects with the goal of delivering them
Cost Effectiveness =
DCost on budget and schedule.
The presented risk analysis is a combination of both qualita-
(equation 2) tive and quantitative risk methods. The generic structure of this

CSC.01.2
 2001 AACE International Transactions
risk analysis for cost control is shown in figure 3. In the risk assess-
ment phase the probabilities and consequences of risks or oppor-
Risk Methods tunities are quantified and using a risk assessment matrix table a
Cost/ Schedule determination of risk is made. Table 1 is an example of a risk
Targets assessment matrix table. Once an expression for the likelihood
Planning and consequence of an event is developed, a risk rating can be
determined. For example, if the likelihood of a labor strike is like-
ly and the consequence of this event is critical, the risk rating from
Risk Methods
table 1 for a labor strike is “high.” Risk ratings are then compared
to risk acceptance levels. and a decision analysis process is used to
Project Control Execution assist management. The activities in the boxes represent risk
assessments. and the activities in the arrow represent a shift to risk
management functions. The basic structure shown in figure 3 is
applied in both the planning and execution phases of a project
except in the execution phase earned value techniques and con-
tinuous monitoring are performed.
Project Delivered on Budget
& on Time
PLANNING PHASE

A method to account for the uncertainty in estimated costs

and schedules applies the results of a qualitative risk assessment
Figure 2—Risk-Based Methodology Applied to Both the
method to simulation during the planning (feasibility or prelimi-
Planing and Execution Phases
nary design) phase of a project to provide a qualitative and quan-

System Definition
Risk Identification
Define Events

Assessment of Assessment of
Probabilities Consequences

Risk Assessment

Risk
Acceptability

Decision
Analysis

Figure 3—Generic System Definition of Risk-Based Cost Control

CSC.01.3
 2001 AACE International Transactions
Table 1—Negative Risk Assessment Matrix Table the last block of figure 4 and has
been quantified to account for
Likelihood level Consequence Assessment uncertainty and potential risks. This
(1) I Negligible II Acceptable III Marginal IV Critical V Catastrophic
process also highlights risks or
(2) (3) (4) (5) (6)
A. Implausible N L L L M opportunities that may be mitigated
B. Unlikely L L L M H or taken advantage of during the
C. Likely L L M H H planning process.
D. Highly L L M H H
Possible
E. Certainty L L M H H Planning Cost and Schedule Risk
Risk Assessment Guide Acceptability
N = Essentially no risk, can assume risk will not occur.
Once the potential risks are high-
L = Low risk, minor project cost escalation.
M = Medium risk, average project cost escalation lighted from the risk assessment
H = High risk, certain or if occurs will result in significant cost escalation. matrix, a method of risk acceptabili-
ty is required. The project team
should propose to management the
titative risk assessment. The qualitative method of the risk assess-
level of acceptable risk. The method for establishing acceptable
ment is performed using a two-step process. First, a checklist
risk should be based on criteria and guidelines established for a
approach is used to identify potential risk and then a risk assess-
particular company or organization. These criteria should be rel-
ment matrix technique is applied using expert judgement to quan-
atively generic so that they can be applied to projects typical for
tify the risk. By using two methods of risk assessment, potential
the organization.
areas of risk that affect the cost and schedule are accounted for.
Risks that have the potential to cause significant cost results
The assessment of cost and schedule risks are then developed by
should be targeted for reduction or control. A two-step process is
a quantitative analysis using simulation.
used for determining risk acceptability: all risk above a certain
qualitative threshold should be targeted for reduction or opportu-
nity, and all other risks should be evaluated by the cost effective-
Planning Cost and Schedule Risk Assessment
ness of risk reduction.
Construction project costs and schedules are typically esti-
Management needs to set the thresholds for risk levels and
mated by developing a single value or “point estimate.” A point
cost effectiveness. Risk events with an acceptable cost effective-
estimate does not include the effects of uncertainty and is simply
ness are deemed acceptable, and mitigation efforts or opportuni-
based on the summation of a number of point estimates for items
ties will be pursued. Negative risks that are deemed unacceptable
of work.
and are not cost effective will probably make a project nonviable.
A risk assessment methodology using simulation is presented
because simulation techniques are readily adapted to the con-
struction industry. This is because construction projects have mul-
Planning Cost and Schedule Decision Analysis Method
tiple and interrelated activities that can be easily modeled. Once
There are three major decisions to be made in the planning
a point estimate is developed, uncertainty can be probabilistically
process. The first one answers the question, “What risk should be
expressed by using probability density functions. Finally, simula-
mitigated or opportunities pursued in the planning phase?” The
tion can be easily performed on current state of the art desktop
second decision area helps to set up the simulation for the devel-
computers.
opment of cost and schedule targets. Third, a decision is required
One difficulty in using simulation to develop cost and sched-
to determine if a project should be pursued furthered into the
ule risks is determining what factors, parameters, or range of val-
execution phase.
ues should be applied to the probability distributions used to rep-
As shown in figure 5, the output from the risk-based cost and
resent the uncertainty of costs and schedules. The simulation
schedule development also includes highlighted risk or opportu-
model can then use information from the risk assessment to devel-
nities. High negative risks and opportunities should be acted on
op appropriate cost ranges modeled by the probability distribu-
during the planning phase. This should have the effect of reduc-
tions.
ing cost and schedule and therefore the original estimate must be
The process for developing the cost and schedule risk data is
redone. Finally, cost and schedule targets are developed that
presented in figure 4. The first step in establishing a cost estimate
include the effects of mitigating high negative risk and seizing
is to breakdown the project using a work breakdown structure
opportunities.
(WBS). Once this is done, a point estimate can be developed for
Also shown in figure 5 are that the results of the risk assess-
each individual work package. Replacing a point estimate for a
ment from the risk matrix are applied to the cost or schedule esti-
work package with a probability density function can better
mate via a simulation method. The risk assessment provides infor-
approximate the cost of each work package by accounting for
mation for the determination of the appropriate range to use in
uncertainty. Care will be required to use the appropriate density
the probabilistic representation of various cost or activities. The
function and associated parameters. The selection of which prob-
range is the measure of dispersion of a distribution about a mean
ability density function is best suited for certain construction oper-
value. For example, if a construction operation is represented by a
ations has been demonstrated by AbouRizk and Halpin [1], and
triangular distribution, the range of values may be arbitrarily
Law and Kelton [9] recommend several alternative distributions.
selected from 90 percent to 110 percent of the mean. Through the
The estimated cost and schedule target for a project is shown in
CSC.01.4
 2001 AACE International Transactions

Project
WBS

Work Package
Point Estimates

Risk or Opportunity
Identified via Risk Check List
Qualitatively Described via
Risk Matrix Work Package
Quantitatively Applied to Estimates with
Cost Estimate via Simulation Uncertainty

Estimated Cost of
Risk Mitigation
Project with
or
Highlighted Risks or
Opportunities
Opportunities

Cost & Schedule

Target

Figure 4—Cost and Schedule Risk Data and Process

CSC.01.5
 2001 AACE International Transactions

Risk Events
Defined
Assess Risk
Probability
Consequences
Risk
Acceptable?
Establish
Risk Assessment
No
Earned Value

Decision
Analysis
Establish Earned Value
Yes

Update
Monitor
Risk Assessment Data
Earned Value Data

Monthly
Update
Project Information
Risk Assessment
Risk Assessment Data
Earned Value
Earned Value Data

Why?
Risk
Review
Yes Cost
Risk Assessment
Variance?
Cost Data

Decision Monthly Cycle

Analysis and Monitor
Action

Project
Completion

Figure 5—Combined Risk Assessment and Earned Value Analysis

CSC.01.6
 2001 AACE International Transactions
results of the risk assessment this range can better represent the
risk involved and is increased or decreased accordingly. For exam-
ple, an activity with a high negative risk might use a range
between 90 percent and 150 percent to reflect the potential for an
adverse consequence.
The decision to go further with the project will be made once
the risks have been highlighted and final target costs and sched-
ules are known. Generally the most important risk issues are costs
and schedule, the capacity of industry to perform the work, and
the risks involved.
A methodology for using a risk-based net present value is used
to determine if the project should be pursued further. This
method is selected because it is relatively simple to apply, yields a
monetary value that includes the time value of money, and can
account for the uncertainty in a project [15].
EXECUTION PHASE
The execution phase of a project begins once a project owner
or governmental agency has given the go ahead for the project.
Actual construction begins in this phase and a cost control
methodology is required to ensure costs remain within the budg-
et. This section presents a cost control methodology that com-
bines risk and earned value analysis techniques to control project
cost.
New information available in the execution phase of a proj-
ect may only require the original risk assessment to be expanded
or updated to reflect any changes in uncertainty, assessment of
consequences and probability, or new risk events. The risk assess-
ment in this phase is now preformed along side an earned value
analysis. Risk acceptability and decision analysis is preformed in
the execution phase as a means to control project costs.
The combined process of risk assessment and earned value
analysis is shown in figure 5. This combined process is shown as
being comprised of establishing and updating both the risk assess-
ment and earned value processes. Baselines for risk and costs are
established as soon as possible in the execution phase. Each
month as new project information and earned value data becomes
available these analyses are updated.
Execution Establish Risk Assessment and Earned Value
The risk checklist, consequence, and likelihood assessments
from the planning phase are reviewed and updated to provide a
risk assessment during the execution phase. This assessment
should begin by reviewing existing documentation such as plans,
specifications, contracts, and actual site conditions. Risk assess-
ment ratings are found using risk assessment matrix tables. To
combine risk assessment and earned value analysis means to per-
form these activities together.
Earned value analysis has two distinct phases. These are
establishing the baseline and measuring actual performance
against this baseline. As early as possible in the project execution
phase, the planned budget should be established and charted as
cumulative cost versus time. The budget baseline or planned
value of the work in earned value terminology is best organized
and analyzed by using spreadsheet software. These spreadsheets
can be easily updated and graphically show trends.
CSC.01.7
The risk assessment provides insight to items of various levels
of risk. These items should be broken out or reduced to manage-
able levels in the earned value analysis. This allows managers to
identify potential origins of variances. The earlier cost problems
or opportunities are identified the better. This allows project man-
agers enough time to correct a problem or seize an advantage to
affect the outcome of a project.
Execution Phase Risk Acceptability
Risk acceptability is required early in a project’s execution life
cycle in order to receive the full benefit of mitigating potential
harm or capitalizing on opportunities. Once potential risks are
flagged, a decision analysis process is used to decide on a best
course of action.
Risk acceptability is shown as a decision block in the upper
right portion of figure 5. If an identified risk is acceptable it only
needs to be monitored during the construction process. An iden-
tified risk event that is unacceptable or an opportunity attractive
enough must be mitigated or the opportunity taken advantage of.
A decision analysis process is used to identify the best solution.
Once these events have been acted on they should be monitored
for the life of the project.
Execution Phase Update Risk Assessment and Earned Value
This risk assessment process should be dynamic or constantly
evaluating risks for the life of the project. Once a project is pro-
gressing, managers need a dynamic risk assessment process that
will not be too time consuming and should be scheduled at regu-
lar intervals. This constant assessment of risk includes updating
risk profiles and should coincide with the updating of the earned
value charts.
In figure 5, this updating of information is depicted in the
lower right hand portion of the figure. Earned value data and risk
assessment data are collected monthly. The type of data collected
for earned value analysis is the actual cost of performing the activ-
ities to date and the physically accomplished value of the activities
performed to date (earned value). Additionally, a review and
reassessment of identified risk profiles needs to be updated along
with the earned value data.
As shown in the lower center portion of figure 5, once the
earned value and risk assessment data are updated, a variance may
be observed. If a variance occurs the reasons for it must be under-
stood and action taken to correct the situation. If a variance does
not occur when the monthly update is made, the risk profiles and
earned value data continue to be monitored through monthly
updates.
Execution Phase Decision Analysis
A decision technique is also required as shown in the bottom
left of figure 5. This decision process is used to decide how a par-
ticular risk is best mitigated or taken advantage of.
For those risks that must or should be mitigated or taken
advantage of, a goal or decision tree analysis is used to determine
the appropriate strategy. A goal tree technique could be used in
this portion of the execution phase for several reasons: time is of
 2001 AACE International Transactions
the essence, the availability of accurate data, and it is systematical
and simple.
Time is of the essence during the execution phase because a
decision must be made early enough to affect the project’s out-
come. This window of opportunity is greatest at the beginning of
a project and decreases proportionally with the time remaining on
a project. The typical complex construction project will be one of
a kind or significantly different from past projects, therefore accu-
rate data on past projects may not be available to populate a simi-
lar decision analysis that requires probabilistic data. Goal trees are
a systematic process that exposes several options for management
to consider. To aid in rapid decision making they are swiftly and
simply constructed.
The advantage of goal trees is speed and simplicity.
Unfortunately goal trees do not provide an expected monetary
value or a probability of success. This may be acceptable due to
the short window of opportunity and the lack of accurate data in
the execution phase. Should time allow and accurate data is avail-
able, decision trees should be used to help decision-makers decide
between alternatives.
Execution Phase Cost Control 2.
In this stage of a project’s life cycle, management takes action
to correct an observed variance. Once a decision has been made
and action taken, the results must be monitored for their effec-
tiveness. This process continues until a project is completed. 3.
ost control is needed in the construction project man-
C agement field because of the high level of uncertain-
ty associated with the cost of building complex struc-
tures. Although there is a potential for projects to be
completed under budget, the complexity involved in construction
requires specific attention to cost control in order to achieve favor-
able results. To be the most effective over the life cycle of a proj-
ect, a cost control system must be applicable to both the planning
and execution phases. The system needs to be simple enough that
it is applicable and generic enough to apply to a wide cross-sec-
tion of projects.
A risk-based cost control methodology was presented that
combines simulation, earned value, and risk analysis techniques
in a novel approach to cost control. This proposed methodology
provides construction project managers with a structured frame-
work to make cost control decisions during the planning and exe-
cution phases of construction. During the planning phase, risks
are identified, assessed, deemed acceptable or unacceptable, a
decision analysis is performed, and risk-based cost and schedule
targets using a simulation technique are developed. During the
execution phase, a similar process is followed, with the addition of
the cost control technique of earned value that is intertwined with
risk assessment updates and decision analysis to provide cost con-
trol. The presented methodology uses goal and decision trees,
where appropriate, to develop the most cost-effective solution to
cost issues.
A salient feature of the presented methodology is the struc-
tured format, graphical expression of risk, and proposed solutions
to mitigate the risk. The structured format allows project team
members to systematically identify, quantify, discuss, and pose
CSC.01.8
solutions to potential cost issues. Risk profiles of risk events are dis-
played, and the cost effectiveness of risk reduction is used to assist
in making risk acceptability decisions. The graphical expressions
of risk also help to determine whether lowering a consequence or
the likelihood of an event will have the greatest effect on lowering
the risk.
The primary objective of the methodology is to control costs
when building complex structures. This is achieved through a
succession of steps culminating in a decision analysis process. The
decisions made must be followed by actions designed to rectify a
problem or take advantage of a situation. The results of these
actions are also monitored to ensure that a correct alternative was
chosen. The cycle of reassessment, analyzing earned value data,
decision-making, and monitoring continues until a project is com-
pleted.
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 2001 AACE International Transactions
William J. Bender, PE
Assistant Professor, Construction Management
Central Washington University
Ellensburg, WA 98926
phone: 509-963-3543
e-mail: benderw@cwu.edu

Bilal M. Ayyub, PE
Professor, Department of Civil and Environmental Engineering
University of Maryland
College Park, MD 20742

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