5.61 There is a demonstrated, systematic, tendency for project appraisers to be overly optimistic. This is a worldwide phenomenon that affects both the private and public sectors.11 Many project parameters are affected by optimism - appraisers tend to overstate benefits, and understate timings and costs, both capital and operational.
5.62 To redress this tendency, appraisers should make explicit adjustments for this bias. These will take the form of increasing estimates of the costs and decreasing, and delaying the receipt of, estimated benefits. Sensitivity analysis should be used to test assumptions about operating costs and expected benefits.
5.63 Adjustments should be empirically based, (e.g. using data from past projects or similar projects elsewhere), and adjusted for the unique characteristics of the project in hand. Cross-departmental guidance for generic project categories is available, and should be used in the absence of more specific evidence.12 But if departments or agencies have a more robust evidence base for cost overruns and other instances of bias, this evidence should be used in preference. When such information is not available, departments are encouraged to collect data to inform their estimates of optimism, and in the meantime use the available data that best fits the case in hand.
5.64 Adjusting for optimism should provide a better estimate, earlier on, of key project parameters. Enforcing these adjustments for optimism bias is designed to complement and encourage, rather than replace, existing good practice, in terms of calculating project specific risk adjustments. They are also designed to encourage more accurate costing. Accordingly, adjustments for optimism may be reduced as more reliable estimates of relevant costs are built up, and project specific risk work is undertaken. Both cost estimates and adjustments for optimism should be independently reviewed before decisions are taken. Annex 4 provides further detail on how to deal with optimism bias.
BOX 12: OPTIMISM BIAS EXAMPLE
| The capital costs of a non-standard civil engineering project are estimated to be £50m NPC in a strategic outline business case (SOBC). No detailed risk analysis work has taken place at this stage, although significant costing work has been undertaken. The project team reports to the project board and applies an optimism bias adjustment of 70%, showing that, for the scope of work required, the total cost may increase by £35 million to £85 million in total. This is based on consultants' evidence, and experience from comparable civil engineering projects at a similar stage in the appraisal process. As this potential cost is unaffordable, the chief executive requests reductions in the overall scope of the project, and more detailed work for the outline business case stage (OBC). As the project progresses, more costs and specific risks are identified explicitly, despite the reduced scope. For the final business case, the optimism bias adjustment is reduced until there remains only a general contingency of 5% for unspecified risks. Without applying optimism bias adjustments, a false expectation would have been created that a larger project could be delivered, and at a lower cost. |
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11 Flyvbjerg, Underestimating Costs in Public Works Projects - Error or Lie, APA Journal (2002)
12 'Review of Large Public Procurement in the UK', published in July 2002 (available at: http://www.hm-treasury.gsi.gov.uk/)