Target Value Design: Target Costing in the Construction Industry

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Features of traditional construction management. Outcome costs are unpredictableexcept that they will very likely be higher than estimated.Budgets are committed without sufficient analysis of feasibility. Early back-of-envelope cost estimates never die. Design is developed with insufficient rega

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Target Value Design: Target Costing in the Construction Industry

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1. Target Value Design: Target Costing in the Construction Industry Dr. Glenn Ballard University of California, Berkeley [email protected] Around the year 2000, I became intrigued with a method Japanese manufacturers were using in their product development processes to manage product profitability. By that time, there was a considerable literature on the topic, which came to be called “target costing”. In 2002, Boldt Construction led the first successful application of this product development-inspired target costing in the construction industry—on a $12 million project for St. Olaf’s College. Subsequently Sutter Health adopted target costing, though under a new name: target value design. Sutter has delivered numerous clinics and medical office buildings using TVD, and is now in the construction phase on the first of three large hospital projects where TVD is being used, and TVD is now in wide use in U.S. healthcare. My goals for this presentation are to help you understand what target value design is and the results achieved using it. At the end, I will share my thoughts on the next phase of developing the methodology, what I call whole life target value design.Around the year 2000, I became intrigued with a method Japanese manufacturers were using in their product development processes to manage product profitability. By that time, there was a considerable literature on the topic, which came to be called “target costing”. In 2002, Boldt Construction led the first successful application of this product development-inspired target costing in the construction industry—on a $12 million project for St. Olaf’s College. Subsequently Sutter Health adopted target costing, though under a new name: target value design. Sutter has delivered numerous clinics and medical office buildings using TVD, and is now in the construction phase on the first of three large hospital projects where TVD is being used, and TVD is now in wide use in U.S. healthcare. My goals for this presentation are to help you understand what target value design is and the results achieved using it. At the end, I will share my thoughts on the next phase of developing the methodology, what I call whole life target value design.

2. Features of traditional construction management Outcome costs are unpredictable—except that they will very likely be higher than estimated. Budgets are committed without sufficient analysis of feasibility. Early back-of-envelope cost estimates never die. Design is developed with insufficient regard to cost constraints and insufficient awareness of cost implications. Cost estimates are done in big batches, increasing the time and cost of design, endangering design completeness and accuracy, and robbing time from downstream phases. Cost estimates increase as design becomes more detailed. The loss of client value from budget-driven cuts in facility functionalities and capacities is enormous. A ‘gleam in the eye’ prompts the question “How much would it cost me to buy X?” rather than “What is X worth to me?”. Price obscures cost, and Cost obscures worth and value. At least in the U.S., outcome costs have typically been higher than estimated, budgets are committed without sufficient analysis of feasibility, design is developed with insufficient regard for cost constraints, cost feedback is provided to design in big batches, reducing its steering impact, cost estimates increase as design becomes more detailed, the response to being overbudget has been to reduce what’s delivered. In my view, management’s focus on buying, on price, has concealed the opportunities for managing cost and cost has not been properly specified in terms of worth and value. At least in the U.S., outcome costs have typically been higher than estimated, budgets are committed without sufficient analysis of feasibility, design is developed with insufficient regard for cost constraints, cost feedback is provided to design in big batches, reducing its steering impact, cost estimates increase as design becomes more detailed, the response to being overbudget has been to reduce what’s delivered. In my view, management’s focus on buying, on price, has concealed the opportunities for managing cost and cost has not been properly specified in terms of worth and value.

3. What is Target Value Design? Price-Profit=Cost vs Price-Cost=Profit Target value design in the construction industry is the practice of constraining design and construction of a capital facility to a maximum cost. It is an appropriate practice for all clients with financial constraints (maximum available funds or minimum ROI requirements) that a capital project must meet in order to be considered successful by that client. Target value design in the construction industry is the practice of constraining design and construction of a capital facility to a maximum cost. It is an appropriate practice for all clients with financial constraints (maximum available funds or minimum ROI requirements) that a capital project must meet in order to be considered successful by that client.

4. Two outcomes of Target Value Design (TVD) that look to be repeatable Projects’ initial scope is completed below market cost—so far as much as 19% below. Expected cost falls as design develops.

5. Sutter Fairfield MOB There are three costs in play here: 1) the “benchmark” cost estimate, based on comparison of the building with other similar buildings, pre-design 2) the target cost, based on what the customer was willing and able to spend,also specified prior to design, and 3) the actual cost at project completion. The target cost ($18.9 million) was set 14.1% below the benchmark ($22.0 million). The actual cost ($17.9 million) for the original scope underran the target by 5.3% and underran the benchmark by 18.6%. There are three costs in play here: 1) the “benchmark” cost estimate, based on comparison of the building with other similar buildings, pre-design 2) the target cost, based on what the customer was willing and able to spend,also specified prior to design, and 3) the actual cost at project completion. The target cost ($18.9 million) was set 14.1% below the benchmark ($22.0 million). The actual cost ($17.9 million) for the original scope underran the target by 5.3% and underran the benchmark by 18.6%.

6. Sutter Fairfield MOB The second predictable outcome of TVD is that the cost estimate falls as design progresses.The second predictable outcome of TVD is that the cost estimate falls as design progresses.

7. “Can it really make that much difference to… consider ends and purposes more carefully before diving into a project? put worth and value before cost? engage project delivery teams in assessing project feasibility? set targets beyond current capabilities? Are you surprised or skeptical about this approach and its results? You may be asking “Can it really make that much difference to…?”Are you surprised or skeptical about this approach and its results? You may be asking “Can it really make that much difference to…?”

8. The TVD Process Develop project business plan Validate the project business plan Set targets for values and conditions of satisfaction Steer design to targets Steer construction to targets Let’s look a bit more closely at the TVD process. Here are the big steps: ……Let’s look a bit more closely at the TVD process. Here are the big steps: ……

9. “Normal” practice vs Target Costing What do I want? What will it cost me? Can I afford it? Can I get it for less? What am I trying to accomplish? What do I need in order to achieve my purposes? What is that worth to me? What can I afford to pay to get it? What can I expect to pay? Is expected cost less than or equal to allowable cost?

10. Here’s one way project business planning happens. The reason for the project is captured in a statement of purpose, then some type of operations cost model is developed. This informs an estimate of benefits in use, which may cause a revision of the purpose statement, but ultimately leads through assessment of available funds to inform the allowable cost. Taking the right hand branch from the use model, a forecast of demand also informs benefits from use, as well as the specification of what’s needed to meet demand. This ‘program’ or scope informs both cost benchmarking and the allowable cost, what the client is able and willing to spend to get the expected benefits from use of the asset. Allowable first cost is a result of answering the questions: What are we willing to pay to get the expected benefits? What can we pay; given the availability of funds? The next step is to rank the project in relation to alternative investments and decide if to fund a plan validation study. There may be too great a difference between the market price and the allowable cost, in which case the client may choose to either revise the business plan or kill the project. If, on the other hand, the project passes the sniff test and compares favorably to alternative investments, a plan validation study is initiated.Here’s one way project business planning happens. The reason for the project is captured in a statement of purpose, then some type of operations cost model is developed. This informs an estimate of benefits in use, which may cause a revision of the purpose statement, but ultimately leads through assessment of available funds to inform the allowable cost. Taking the right hand branch from the use model, a forecast of demand also informs benefits from use, as well as the specification of what’s needed to meet demand. This ‘program’ or scope informs both cost benchmarking and the allowable cost, what the client is able and willing to spend to get the expected benefits from use of the asset. Allowable first cost is a result of answering the questions: What are we willing to pay to get the expected benefits? What can we pay; given the availability of funds? The next step is to rank the project in relation to alternative investments and decide if to fund a plan validation study. There may be too great a difference between the market price and the allowable cost, in which case the client may choose to either revise the business plan or kill the project. If, on the other hand, the project passes the sniff test and compares favorably to alternative investments, a plan validation study is initiated.

11. The Validation Study If the allowable cost is greater than or equal to the initial expected cost, the business plan is provisionally viable. The client can acquire the asset without paying more than it’s worth to them to have and use it. Plan validation consists in checking that the expected cost is really less than the allowable. If the allowable cost is less than the initial expected cost, the business plan may not be viable. In this case, plan validation consists in determining if innovations in design of product and process are likely to sufficiently reduce the expected cost. Either way, the plan validation study is performed by key members of the team that will deliver the project if funded. These companies will be members of the risk pool, and will have some or all their profits at risk for achieving the project budget and schedule. This study does not develop the design beyond the massing model shown above. If the allowable cost is greater than or equal to the initial expected cost, the business plan is provisionally viable. The client can acquire the asset without paying more than it’s worth to them to have and use it. Plan validation consists in checking that the expected cost is really less than the allowable. If the allowable cost is less than the initial expected cost, the business plan may not be viable. In this case, plan validation consists in determining if innovations in design of product and process are likely to sufficiently reduce the expected cost. Either way, the plan validation study is performed by key members of the team that will deliver the project if funded. These companies will be members of the risk pool, and will have some or all their profits at risk for achieving the project budget and schedule. This study does not develop the design beyond the massing model shown above.

12. The TVD Process Develop project business plan Validate the project business plan Set targets for values and conditions of satisfaction Steer design to targets Steer construction to targets Let’s look a bit more closely at the TVD process. Here are the big steps: ……Let’s look a bit more closely at the TVD process. Here are the big steps: ……

13. Setting the target cost and project schedule The target cost is set equal or close to the allowable when the initial expected cost is substantially greater than the allowable. Example: On the Cathedral Hill Hospital project, the allowable cost was estimated to be 13% less than the initial expected cost. The target cost was set equal to the allowable until the expected cost was reduced below the allowable, at which time a new target cost was set $70 million below the allowable. When the initial expected cost is equal to or less than the allowable, the target cost is set lower than allowable to drive innovation. The target cost is set equal or close to the allowable when the initial expected cost is substantially greater than the allowable. Example: On the Cathedral Hill Hospital project, the allowable cost was estimated to be 13% less than the initial expected cost. The target cost was set equal to the allowable until the expected cost was reduced below the allowable, at which time a new target cost was set $70 million below the allowable. When the initial expected cost is equal to or less than the allowable, the target cost is set lower than allowable to drive innovation.

14. This graph is from Sutter Health’s Cathedral Hill Hospital Project, where the target cost for construction was first set at $911 million in the client’s project business plan. Despite an initial conceptual cost estimate $60 million above that target, the client decided to initiate design. As you can see, over time, the cost estimate came down, finally equaling the target cost after 14 months. At that time, Sutter set a new target cost $70 million below the first, and set up a gain/pain sharing agreement with the project team. This profile of declining cost has been characteristic of all the TVD projects of which I’m aware. I believe now six major healthcare companies in the U.S. have used TVD on their projects, with similar results to those shown here and those achieved at the Fairfield Medical Office Building project. Among those six is Unified Health Services, the largest U.S. healthcare company, which has adopted TVD as its standard for project delivery.This graph is from Sutter Health’s Cathedral Hill Hospital Project, where the target cost for construction was first set at $911 million in the client’s project business plan. Despite an initial conceptual cost estimate $60 million above that target, the client decided to initiate design. As you can see, over time, the cost estimate came down, finally equaling the target cost after 14 months. At that time, Sutter set a new target cost $70 million below the first, and set up a gain/pain sharing agreement with the project team. This profile of declining cost has been characteristic of all the TVD projects of which I’m aware. I believe now six major healthcare companies in the U.S. have used TVD on their projects, with similar results to those shown here and those achieved at the Fairfield Medical Office Building project. Among those six is Unified Health Services, the largest U.S. healthcare company, which has adopted TVD as its standard for project delivery.

15. “Lower the river to reveal the rocks” Cathedral Hill got to the point where the expected cost was less than allowable, at which time, a more aggressive target was set for cost. This is a strategy for funding value-adds to the project scope within the existing budget. I see this an application of Taiichi Ohno’s advice to “Lower the river to reveal the rocks”; i.e., to deliberately reduce the buffers of money, time, capacity or inventory to reveal where the system needs improving. Cathedral Hill got to the point where the expected cost was less than allowable, at which time, a more aggressive target was set for cost. This is a strategy for funding value-adds to the project scope within the existing budget. I see this an application of Taiichi Ohno’s advice to “Lower the river to reveal the rocks”; i.e., to deliberately reduce the buffers of money, time, capacity or inventory to reveal where the system needs improving.

16. Chief Engineer Suzuki’s YETs Great high-speed handling/stability Fast and smooth ride Super quiet Elegant styling Warm Great stability at high speed A pleasant ride Low fuel consumption Light weight Great aerodynamics Functional interior Low aerodynamic friction This is, I think, a great example of self-imposed necessity. Suzuki was the Chief Engineer on Toyota’s Lexus product development project. The goal was to enter the luxury car segment of the market. The strategy was to produce a car that exceeded competitors in performance. To operationalize that strategy, Suzuki developed his Yets; a demand that the car they designed and manufactured would have previously incompatible characteristics: great high-speed handling and stability, yet a pleasant ride….. To illustrate, consider ‘Super quiet yet light weight’. At that time, the accepted engineering solution for vehicle-induced noise was to use mass to absorb vibration. Suzuki took that solution off the board, ultimately forcing the drive train engineers to redesign the engine to tighter tolerances, thus reducing vibration at its source. This is, I think, a great example of self-imposed necessity. Suzuki was the Chief Engineer on Toyota’s Lexus product development project. The goal was to enter the luxury car segment of the market. The strategy was to produce a car that exceeded competitors in performance. To operationalize that strategy, Suzuki developed his Yets; a demand that the car they designed and manufactured would have previously incompatible characteristics: great high-speed handling and stability, yet a pleasant ride….. To illustrate, consider ‘Super quiet yet light weight’. At that time, the accepted engineering solution for vehicle-induced noise was to use mass to absorb vibration. Suzuki took that solution off the board, ultimately forcing the drive train engineers to redesign the engine to tighter tolerances, thus reducing vibration at its source.

17. ‘Lowering the river’ in construction Applying artificial necessity on construction projects can be done by reducing the amount of money made available for design and construction of facilities with pre-specified functionalities, capacities and properties; increasing the minimum acceptable ROI, or increasing the valued facility attributes required beyond what current best practice can deliver for a given cost. Similar strategies can be applied for time.

18. The TVD Process Develop project business plan Validate the project business plan Set targets for values and conditions of satisfaction Steer design to targets Steer construction to targets Let’s look a bit more closely at the TVD process. Here are the big steps: ……Let’s look a bit more closely at the TVD process. Here are the big steps: ……

19. Designing to the Target Cost Allocate the target cost to systems, subsystems, components, … Have cost modellers provide cost guidelines to designers up front, before design begins. Incorporate value engineering/value management tools and techniques into the design process. Use computer models to automate costing to the extent feasible.

20. Helping suppliers improve Far from squeezing designers, suppliers and builders ever harder, the enlightened client provides commercial incentives and organizational structures that enable and encourage innovation in practices and streamlining of processes. When they assume financial risk, designers, suppliers and builders can apply target costing to their own projects.

21. Yes, it really does make that much difference to… inform designers of cost implications before designs are fully developed. provide rapid cost feedback to designers. allocate facility target cost to cross functional teams responsible for designing and building facility systems. follow the rule that the facility target cost cannot be exceeded, and cannot be saved through scope or quality reductions. allow money to move across organizational boundaries in search of the best project-level investment.

22. But let’s not forget the basics To design for value delivery… understand how the facility will be used, at occupancy and after, before designing. understand owner conditions of satisfaction for delivery of the facility; typically cost and time. link what’s wanted and owner conditions of satisfaction and keep them linked when either changes—don’t let scope and cost drift apart. set stretch goals in scope, cost or time to spur innovation. align commercial interests with delivery of value to the owner. design to target values and conditions of satisfaction—do not design, then cost.

23. Current Research Project: Whole Life Target Value Design Objective: Deliver greater value to customers Method to be developed and tested: In project definition: Determine the paying customer’s initial allowable cost from an operations cost model—from how the assets will be used. In design: Link the product model to the operations model to evaluate the impact of design alternatives on whole life costs and benefits. Adjust the allowable cost to changes in expected return on investment. In project financing: Seek lenders willing to adjust project budgets in design. I’m switching topics now, from practices already in use the development of different practices, which I call “whole life TVD”. I’m switching topics now, from practices already in use the development of different practices, which I call “whole life TVD”.

24. Everyone knows that first (capital) costs are small relative to the costs to operate and maintain assets. If the comparison is made to the cost to use the asset, which includes staffing, the difference is even greater. This data from the U.K.’s National Health Service is representative: If design costs are a 0.1, construction costs are a 1.0, O&M over a 20 period is a 4.3, and business costs over the same period are a whopping 42! As for the benefits from asset use, in this case, healthcare outcomes, obviously they must be larger yet than the sum of all these costs. Everyone knows that first (capital) costs are small relative to the costs to operate and maintain assets. If the comparison is made to the cost to use the asset, which includes staffing, the difference is even greater. This data from the U.K.’s National Health Service is representative: If design costs are a 0.1, construction costs are a 1.0, O&M over a 20 period is a 4.3, and business costs over the same period are a whopping 42! As for the benefits from asset use, in this case, healthcare outcomes, obviously they must be larger yet than the sum of all these costs.

26. Challenges Persuade clients to develop an operations cost model and use it to calculate their return on investment, and hence what they are willing to invest to get that return. Persuade clients to give the operations cost model to the design team. Learn how to link the product and operations models so changes in the former are reflected in the latter. Persuade financiers to allow a floating budget during design. Learn how to design to a moving target without destroying the discipline that comes from fixed targets.

27. TVD Concepts & Methods Ends-Means-Conditions of Satisfaction: The heart of project management is defining and aligning the ends or purposes the constructed assets are to serve, the means for achieving those ends, and the customers’ conditions of satisfaction for receiving value from possession of the assets—typically cost, time and location. Ends and conditions of satisfaction are set in project definition, thus defining the design task. Design specifies the means. Construction realizes that specification in physical assets.

28. TVD Concepts & Methods-2 That has value which enables realization of purpose. Values are conditions of satisfaction. Targets are set for program and for customer conditions of satisfaction. The program specifies the functionalities and capacities needed in the constructed assets for them to serve customer ends. Targets may be expressed in terms of delivering more value for a given amount of money or time, or delivering a given value for less money or time.

29. TVD Concepts & Methods-3 Worth of an asset: What a buyer of constructed assets is willing to pay to acquire them. Allowable cost: what a buyer of constructed assets is willing and able to pay to acquire them. There is no assurance that the buyer will be able to pay what the assets are worth to them. Expected cost: what a constructed asset is expected to cost before it is designed (initial expected cost) and during the design process (‘drifting cost’ in product development literature).

30. TVD Concepts & Methods-4 Conceptual estimating: methods for estimating the initial expected cost of an asset from programmatic data. Rapid estimating during design Business plan validation: assessment of the feasibility of providing the means aligned with project ends and conditions of satisfaction. Validation is done by the key design and construction professionals who will deliver the project if funded, and whose profits will be contingent upon delivering to targets.

31. TVD Concepts & Methods-5 Target cost: the budget for design and construction of constructed assets, based on assessment of the relationship between their allowable cost and expected cost. Steering design to targets Steering construction to targets

32. Questions? Comments?

33. Target Value Design Research Describe industry practice Explain outcomes Promote use Further Develop the methodology Project Business Planning Estimating Costs & Benefits Validating Project Business Plans Designing to Targets Building to Targets

34. TVD Research: DEVELOP A: Project Business Planning A-1: Develop/Validate a process(es) for project business planning A-2: Explore the feasibility from a capital financing perspective of a budget that varies during design. B: Estimating Costs & Benefits B-1: Develop/Validate method(s) for estimating market cost from programmatic data B-2: Develop/Validate method(s) for modeling facility use, costs & benefits (Whole Life)

35. TVD Research: DEVELOP B-3: Develop/Validate method(s) for determining allowable cost B-4: Develop/Validate method(s) for estimating (determining expected cost) from programmatic data B-5: Develop/Validate method(s) for rapid estimation (determining expected cost) from design data B-6: Link the project's product model to its operations (use) model to estimate the impact on whole life costs and benefits of design alternatives

36. Project Business Planning Research: Private Healthcare Companies Descriptive and Exploratory Descriptive Describe and compare project business planning practices Identify differences Exploratory: What are the potential benefits to project business planning of… Modeling asset operations and cost using discrete event simulation—to determine expected costs and benefits of business use of the asset Determining an allowable cost (asset worth) from expected benefits-in-use vs estimates of cost to procure Engaging industry professionals in validating business plans

37. Project Business Planning Research: Private Healthcare Companies Evaluative and Experimental Evaluative: What differences in project business planning practice make a difference in outcomes? Experimental: Test practices found in comparative evaluation and exploration through… Simulations Case studies (completed projects) Field trials (new projects)

38. UHS Sutter Health Executive Summary Project Scope Current Situation Competitor Analysis Market Share Analysis Population & Income Trends Demand Analysis Operating Plan Marketing Plan Risk Assessment Financial Analysis & Pro Forma Executive Summary Project Overview Project Justification Impact on Key Stakeholders Physician Strategy Performance Measures & Strategic Fit Key Success Factors Marketing, Branding & Communication Plan Risks & Mitigation Exit Strategy Financial Analysis Implementation What does Success look like? Timeline to Achieve Project Goals Key Persons Responsible for Project Success

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