Procedures for dealing with optimism bias in transport planning

Executive summary

Introduction and rationale

The Supplementary Green Book Guidance on Optimism Bias (HM Treasury 2003) with reference to the Review of Large Public Procurement in the UK (Mott MacDonald 2002) notes that there is a demonstrated, systematic, tendency for project appraisers to be overly optimistic and that to redress this tendency appraisers should make explicit, empirically based adjustments to the estimates of a project's costs, benefits, and duration.

HM Treasury recommends that these adjustments be based on data from past projects or similar projects elsewhere, and adjusted for the unique characteristics of the project in hand. In the absence of a more specific evidence base, HM Treasury has encouraged departments to collect data to inform future estimates of optimism, and in the meantime use the best available data.

In response to this, the Department for Transport (DfT), has contracted Bent Flyvbjerg in association with COWI to undertake the consultancy assignment "Procedures for dealing with Optimism Bias in Transport Planning".

The present Guidance Document is the result of this assignment.

Objective

The main aims of the present Guidance Document are to:

• provide empirically based optimism bias up-lifts for selected reference classes of transport infrastructure projects ¹ ; and
• provide guidance on using the established optimism bias uplifts to produce more realistic forecasts for the individual project's capital expenditures.

Furthermore, the underlying causes and institutional context for optimism bias in British transport projects are discussed and some possibilities for reducing optimism bias in project preparation and decision-making are identified.

The guidance is however not designed to provide comprehensive information on the range of tools that exist to prevent optimism bias, including project management and risk management techniques. Reference should be made to the Green Book and related sources of guidance, including the Office of Government Commerce.

The established uplifts

The types of transport schemes under the direct and indirect responsibility of the Department for Transport have been divided into a number of distinct groups where the risk of cost overruns within each of the groups can be treated as statistically similar.

For each of the groups, a reference class of completed transport infrastructure projects has been used to establish probability distributions for cost overruns for new projects similar in scope and risks to the projects in the reference class.

Based on this, the necessary uplifts to ensure that the risk of cost overrun is below certain pre-defined levels have been established. These up-lifts are reflected in the table below.

Table 0: Applicable capital expenditure optimism bias uplifts

Category	Types of projects	Applicable optimism bias uplifts
		50% percentile	80% percentile
Roads	Motorway Trunk roads Local roads Bicycle facilities Pedestrian facilities Park and ride Bus lane schemes Guided buses on wheels	15%	32%
Rail	Metro Light rail Guided buses on tracks Conventional rail High speed rail	40%	57%
Fixed links	Bridges Tunnels	23%	55%
Building projects	Stations Terminal buildings	4-51%*
IT projects	IT system development	10-200%*
Standard civil engineering	Included for reference purposes only	3-44%*
Non-standard civil engineering	Included for reference purposes only	6-66%*

*Based on Mott MacDonald study, p32, no probability distribution available.

Using the established uplifts

The established uplifts for optimism bias should be applied to estimated budgets at the time of decision to build a project. The approval stage is equivalent to the time of presenting the business case for a project to the Department for Transport with a view to obtaining the go or no-go for that project. The uplifts refer to cost overrun calculated in constant prices.

In relation to the appraisal requirements for Local Transport Plans (LTPs) the application of up-lifts should be in connection with the submission of the appraisal information (Annex E) provided by authorities to help determine the allocation of resources for five-year programmes and major schemes. The application of the uplifts should be transparent for the appraiser.

If, for instance, a group of planners were preparing the business case for a new motorway, and if they or their client had decided that the risk of cost overrun must be less than 20%, then they would use an uplift of 32% on their estimated capital expenditure budget. Thus, if the initially estimated budget were £100 million, then the final budget taking into account optimism bias at the 80%-level would be £132 million. If the planners or their client decided instead that a 50% risk of cost overrun was acceptable, then the uplift would be 15% and the final budget £115 million.

Similarly, if a group of planners were preparing the business case for a metro rail project, and if they or their client had decided that with 80% certainty they wanted to stay within budget, then they would use an uplift on capital costs of 57%. An initial capital expenditure budget of £300 million would then become a final budget of £504 million. If the planners or their client required only 50% certainty they would stay within budget, then the final budget would be £420 million.

It follows that the 50% percentile should be used only in instances where investors are willing to take a high degree of risk that cost overrun will occur and/or in situations where investors are funding a large number of projects and where cost savings (underruns) on one project may be used to cover the costs of overruns on other projects. The upper percentiles (80-90%) should be used when investors want a high degree of certainty that cost overrun will not occur, for instance in stand-alone projects with no access to additional funds beyond the approved budget. Other percentiles may be employed to reflect other degrees of willingness to accept risk and the associated uplifts can be found in the Guidance Document.

Causes of optimism bias and possible cures

Transport projects are inherently risky due to the long planning horizon and complex interfaces. Often the project scope or ambition level will change significantly during project development and implementation. Changes may be due to uncertainty at the early project stages on the level of ambition, the exact corridor, the technical standards, project interfaces and geotechnical conditions, etc. Hence, a certain degree of budget uncertainty exists which will typically be reduced through the project cycle.

However, the complexity should not be a surprise to the experienced planner as the occurrence of a certain number of unplanned events is the norm rather than the exception in transport infrastructure projects. It is therefore relevant to ask if there are more deep-seated causes of optimism bias that can explain why project planners do not set aside substantial contingencies when massive evidence show that initial budgets for transport infrastructure projects are characterised by pronounced optimism bias.

Theories on cost overrun suggest that optimism bias could be caused by a combination of how the decision-making process is organised and strategic behaviour of actors involved in the planning and decision-making processes. Our analysis indicates that political-institutional factors in the past have created a climate where only few actors have had a direct interest in avoiding optimism bias.

At the same time it is important to recognise that the introduction of optimism bias uplifts will establish total budget reservations (including up-lifts) which for some projects will be more than adequate. This may in itself have an incentive effect which works against tight cost control if the total budget reservation is perceived as being available to the project.

This makes it important to combine the introduction of optimism bias uplifts with maintained incentives for promoters to undertake good quantified risk assessment and exercise prudent cost control during project implementation. It is therefore recommended that the introduction of optimism bias uplifts are supported by:

• emphasis on establishing realistic budgeting as an ideal and de-legitimise over-optimistic budgeting as a routine;
• introduction of fiscal incentives against cost overruns e.g. through requiring local co-financing of project cost escalation where possible;
• formalised requirements for high quality cost and risk assessment at the business case stage, and
• introduction of independent appraisal supported by necessary enforcement measures.

The full report is available from the link below.

¹ The present guidance document establishes empirically based uplift for capital expenditures for transport infrastructure projects based on the full business case (time of decision to build). Similar works duration uplifts and reduction factors for project benefit have not been established due to lack of statistical data.

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