When consumers return to the skies again, they may do so in Boeing’s 787 Dreamliner. But the project or “temporary organization” created to make this plane a reality ran much over-budget and created significant dissatisfaction among Boeing’s customers. Such cost overruns are a common outcome of major engineering and construction projects. In fact, studies show that nine out of ten have significant cost overruns, with overruns above 100 percent quite common. The implications of cost overruns go beyond financial metrics and can include reputational damage, litigation, and future overreliance on rigid and formalized relationship features. A new study in the Journal of Marketing explores how these projects can be better managed so that such cost overruns are minimized.
Managing suppliers and subcontractors, who can run into the hundreds in major projects, is an enormously difficult task. It necessitates considerable coordination and monitoring in a context where parties often have not worked together and lack shared procedures or rules and where there is a great need to get up to speed quickly. As one of Boeing’s engineers put it, “The importance of thorough planning, accounting for all interdependencies, cannot be overestimated.” Starting from this coordination and monitoring challenge, our research team studies, in the context of 429 completed construction projects, how duration of the project and reliance on prior ties relate to selection criteria and pricing formats.
We find that supplier selection and pricing format decisions that reflect key characteristics of the project, such as the size of the project, duration, and type of customer, are best at reducing a significant part of the cost overruns observed. Through a set of carefully considered scenarios we conduct “what-if” analyses to show that the reductions in costs can be substantial. We also show that the benefits from getting selection right outweigh those that result from getting pricing right, suggesting that selection should be, relatively speaking, a higher strategic priority for a firm.
This study is particularly useful to managers who wish to minimize cost overruns in projects. We propose that pricing and selection, which are typically fixed at the start of a project, are predictive of cost overruns that can only be observed after a project is completed, typically months or years after. Thus, there is some durability to these pricing and selection decisions. The pricing and selection aspects we consider—fixed vs. variable pricing and selection on price vs. ability—were proposed by industry and thus hold particular managerial appeal. We also show that simple managerial heuristics, such as only relying on price-based selection or deploying fixed pricing, are unlikely to be effective at minimizing cost overruns.
Read the authors’ slides for sharing this material in your classroom.
Elham Ghazimatin, Erik Mooi, and Jan Heide, “Mobilizing the Temporary Organization: The Governance Roles of Selection and Pricing,” Journal of Marketing.
Go to the Journal of Marketing