Direct and Indirect Project Costs
The distinction between direct and indirect project costs in a capital cost estimate is sometimes not so clear. Where do we draw the line?
There is a question that comes up quite often. What are the indirect costs for a capital cost estimate? For the person who is not very familiar with the various delivery methods and contract types for the construction projects, it can get confusing. I am writing this post to shed some light on the topic. While there might be variations of the methods and contract types methods listed below, I think the main ones are all included.
As a cost consultant, I do cost estimating, detailed and conceptual, for general contractors and engineering firms, in a few industries and construction sectors: infrastructure, ports and marine, oil and gas, mining and commercial projects.
Working across this large spectrum of construction project types and various project delivery methods, I often have to define the indirect costs for each instance. So what is the definition of indirect costs? Is there a template? My definition of indirect costs is: it depends on who is asking?
My best way to explain the direct vs. indirect costs is to look at the different types of project delivery methods. The project delivery is the process by which all the aspects required for a complete project are put together, and the contractual relationships required.
Below is the list of project delivery methods.
1. Design-bid-build
The contractual relationship is Owner-A/E, Owner- Contractor and Contractor-Subcontractors/Vendors. In this type of project delivery method, the contractor is selected through the competitive tender process.
2. Design-Negotiate-Build
The contractual relationship is Owner-A/E, Owner- Contractor and Contractor-Subcontractors/Vendors. In this instance, the contractor is selected through direct negotiations and awards.
3. Construction Management (CM)
There are two types of CM project delivery types:
- At risk. In this instance, the CM is performing some construction activities, usually, the ones associated with the most risk, so some of the risks are transferred from Owner to the CM. The contractual relationship is Owner-CM, Owner-Vendors, and Owner-Subcontractors.
- Typical CM type. In this case, the CM is performing no construction activities. The contractual relationship is Owner-CM, Owner-Vendors, and Owner-Subcontractors. The CM firm does not perform any construction activities.
4. Design-Build
Contractual relationships: Owner-Design-Build Contractor, Design-Build Contractor-Engineering Firm, Design-Build Contractor-Subcontractors/Vendors. The Design-Build Contractor and Engineering firm, sometimes a selected subcontractor as well, can form a joint venture to act as a stand-alone entity for that specific project.
The types of contracts used for the above projects delivery methods can be any of the following:
- Lump sum or fixed price
- Unit price
- Cost plus fee
- Cost plus with a guaranteed maximum price.
The indirect costs for all types of project delivery methods mentioned above are included in the contract price. A detailed cost estimate needs to be performed to determine the indirect costs, but such costs are not broken out from the contract price. The cost estimating methodology for all of the above is detailed cost estimating. At the base of it is the typical contractor’s cost estimating approach.
5. EPC
The contractual relationships are Owner-EPC Contractor, EPC Contractor-Engineering firm, EPC Contractor-Vendors and EPC Contractor-Subcontractors. The contractor performs all the construction activities, with their own forces or subcontractors, assumes all the risks, and the contract type is lump-sum. Again, the indirect costs are build-in the contract price.
The contractor’s estimator develops the direct and indirect costs as they relate to the contractor. The cost estimate types are usually conceptual to a detailed cost estimate, and all variations in-between.
6. EPCM
This type of project delivery method is a professional services contract between the Owner and the EPCM firm. The EPCM firm does not perform any construction activities, therefore, does not have any other contractual basis other than the one with the Owner.
The EPCM firm, under the services contract with the Owner, is responsible for performing the following tasks: Project Management, Engineering, Procurement and Construction Management.
The Owner has contracts with Vendors and Contractors, and the EPCM firm manages such contracts on behalf of the Owner. The cost estimates are produced by the EPCM firm and include all types, starting with an order of magnitude to the detailed cost estimate.
It is this type of project delivery method where it seems that there are roadblocks in defining the indirect costs. Let’s look at the categories of indirect costs which should be included, and where, under the EPCM contract delivery method:
- Contractors performing the construction activities will have their indirect costs to support their scope of work.
- The EPCM firm will have their specific indirect costs to support the Project Management, Engineering, Procurement and Construction Management tasks. Such costs are included under the EPCM costs. The EPCM costs, as a whole, are project indirect costs.
- The Owner costs are project indirect costs. In this category, we have:
- project financing,
- Owner’s project management team,
- legal costs, permits,
- rights of way, land acquisition,
- public outreach,
- freight for Owner’s supplied equipment and materials,
- taxes and duties,
- bonds and insurance,
- escalation,
- Owner’s reserve,
- safety program,
- campsite(s),
- commissioning and operation readiness (if not included in Construction Management).
There can be variations of all of the above, depending on the contracting strategy and the terms of the EPCM services contract. A distinction should be always made between project direct and indirect costs and the contractor’s indirect costs.
The contractor’s indirect costs are included in the contractor’s total costs and fall under the project direct costs. Some Owners require that the contractor’s indirect costs be estimated and shown as a separate line for various reasons. We should not confuse this request with the fact that the contractor’s indirect costs are part of the project’s direct costs.
Do you have any comments? I would like to know what is your approach to classifying the indirect costs.
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