Why Are Published Price Indices Important?

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Today we’re joined by Dr Alexia Nalewaik to discuss the topic of why are published price indices important. Dr Alexia Nalewaik has over 25 years of experience in audit, estimating, and cost risk management. She is a Fellow of RICS Americas, AACE International, the Guild of Project Controls, and ICEC. She is a member of the governing council of ICEC.

Alexia is also the Past President of AACE International, and a Past Chair of ICEC, the International Cost Engineering Council. She has published two books on performance audit and reporting and her current research focuses on cost indices and societal value.

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Highlights from Episode 146:

“Why Are Published Price Indices Important” with Dr Alexia Nalewaik

Can you tell us a bit about yourself and your background?

I started out with a degree in physics and it turns out, I wasn’t all that interested in the theoretical. I was much more of a hands-on person. But I did finish a bachelor’s degree and received some good advice from my advisor. He told me that if I liked architecture and I liked physics, perhaps if I put them in a blender, and I should go study civil engineering. So, I ended up with a master’s degree in civil structural engineering. From there, that was sort of the way I leapfrogged into the world of projects, specifically construction projects, and then much later in my life, some 20 years after my master’s degree, I got my tail properly in a twist over something and ended up with a PhD.

So, you had started with physics and went with many different paths until you finally made it to this one, right?

I really don’t think there is a traditional path to project management. I think people come to project management from all walks of life and project management is really a term for a structured process or methodology or structured approach to something, really thinking about it. And as a result, you can have project management in manufacturing, IT, and construction.

Can you explain the concept of the price indices?

Price indices are generally published books or published databases that provide prices of typically unit costs of something. So, the different kinds of price indices that we see might have a narrow focus such as process plants or construction. Some might focus on unit prices and sort of the real nitty-gritty of what individual components of a project cost. Others might be something more along the line of assemblies. So, square meter building costs or what it costs per meter of countertops, or what have you, and then you look at other industries that perhaps have an even narrower focus or maybe even represent in a market basket of types.

Government-published consumer and producer price indices often rely on what’s called a market basket, which is a mix of goods that are typical for a particular industry and they report whether costs are going up or down. So, really price indices vary considerably in their structure and content. They might be very detailed on specific unit prices, they might just talk about a building as a whole or different building types. And then, in other cases, they might just identify trends, and quantify the percentage increase or decrease within a particular period, or they might not quantify at all.

Is there a manual that’s used or universal methodologies, or how does it really come about to be created?

It’s actually really interesting. I have partnered with the team at Deakin University in Melbourne, to address a study of the Australian Institute of Quantity Surveyors price index, which they publish on a periodic basis. We received a grant to study this and so in the course of looking at this, it’s been really quite interesting to see how these price indices are developed and produced.

Typically, it’s a very labor-intensive process and it’s a massive data collection process, then validation of the data sometimes the development of a model to analyze the data, and then ultimately publication. Then some of these published indices, some are available as a book, some are available as a service that’s issued, perhaps quarterly or semi-annually or annually, and then, even more of them published their price indices in conjunction, with estimating software. So, while an estimator or quantity surveyor is working, putting together an estimate for a project, they might be able within the software to simply click on “Hey, what’s the cost of stainless steel pipe at the moment?”

It’s incredible. What we discovered in the course of our research is that it’s incredibly labor-intensive. As a result, it is quite a bother to produce. Some indices that are produced are produced by companies that are very invested in publishing this as part of their business model. And these businesses, a lot of the ones that I’ve seen have been in the construction arena and also in the valuation area of property valuation. But that’s what I’m saying because it’s my industry I would not doubt that there are published price indices for manufacturing, for IT, for things like this, but I’m not seeing them simply because that’s not what I’m working in. And so, I’m not working with those on a particularly regular basis.

Are these figures constantly updated to link with whatever market trends are going on at the moment? Or is it just like a constant fixed price?

The intent is generally to update them constantly, but that’s a bit difficult. So, the way that these are used is that estimators and quantity surveyors may use them to validate their own estimates and see if they’re in the right ballpark. Estimators tend to rely on historical costs, vendor quotes, publicly published prices in a catalogue or these days on a website, quotations from vendors’ proposals, from vendors, these sorts of things, but every once in a while you come across a gap and you’re thinking “I need a number for that. Where am I going to find a number?” So that’s another instance when one might use a published price index.

The other thing is that these price indices could be useful to compare what’s been published in the index against a vendor quote, or a proposal. So, early in my career, I ticked off a lot of local small contractors when I was doing home renovations and made myself very unpopular in the city and had to stop doing that. But a lot of quotes were high. Of course, they’re just trying to see what the market would bear. So, I really did tick off an awful lot of small businesses. Anyway, that’s how these are used in industry. The other thing is that these are also some of the major price indices that are accepted in litigation as reliable sources of data. So that’s another use of information.

Would you be able to explain or expand upon why they are important for industries such as engineering and construction? Is it to do with ensuring that they have all the correct costs and that they’re not going to be under budget doing a job or to ensure that they are actually going to make a profit?

These can be used by many sides of the industry, so they can be used by owner quantity surveyors or by quantity surveyor contractors who are interested in putting together a price proposal for projects, winning it, and then ensuring that they have enough profitability to stay in business or grow their business. From an owner’s perspective, the intent is to put together an estimated cost of a proposal. And then ensure that funding is received for those, for example, or to requisition the funds that are necessary and then compare contractors or vendor proposals against what was originally budgeted for the project. It’s important as a mechanism for cross-checking and validating in various forms and fashions.

What do the different stakeholders use a price index for like, when, why, and how do they actually use them?

I think I may have actually addressed some of that already. And I will say that again, everything that I’m experienced with has had a construction focus. So these could be used at almost any particular phase of a project, could be everything from project ideation and setting an initial sort of vague range of estimates and then into the design and development phase, trying to project what the manufacturer construction phase is going to look like in terms of cash flow. And then in the middle of the project again, keeping an eye on what is occurring with the escalation in projects or how the market is changing in terms of what was budgeted or what’s coming down the line for the project and comparing contractor and vendor quotes.

What risks are there in using a price?

The biggest risk is not understanding the price index and how it is intended to be used. And here, I’m going to expound a little bit about the differences between cost price and value. So, some indices are very specifically a price index. Some are a cost index and it’s entirely possible that neither of those reflects value. When we talk about cost, we’re talking about what it takes to produce or up to produce a particular item, and I’m going to come back to that, maybe a meter of stainless steel pipe, that’s one-inch diameter, a certain thickness and it takes a certain amount to create or manufacture that.

Then you look at price and price is what a seller is offering that item for or what you might expect to pay for it. Now that will include the producer’s fees and markup, and you’ll also need to consider shipping and taxes in the ultimate amount that you pay for that item. So, you need to understand really, and have a sense of the basis of that price index.

So, if you look at them as a means index, they spend an entire chapter at the beginning of the index explaining that the costs that are listed in the index are reflective of the unit cost of a particular item, and the labor that you might reasonably expect to use in installing that item. However, they don’t necessarily include shipping taxes, markups, contractor fees, profit, and all the various markups that you have if you’re in addition, hiring an architect and engineer, the contractor and all these others.

So, there will be a number of add-ons, plus corporate overhead for your own overhead and then, of course, an escalation or a price bump or lowering that’s related to the region in which the project is occurring. So, the public published prices for a fairly generic major town. But if you’re somewhere else in the world, those costs are going to go up or down comparatively and you see that even with salaries around the world. The salary first, the same position can vary depending on what city you’re in and the cost of living in those cities.

The key risk is ensuring that you understand the basis of it and that you understand, how current, or how frequently, those indices are updated. So, it’s really ensuring that you understand the index and how it’s really intended to be used because you can go quite sideways if you haven’t paid attention to the fine print.

Show Notes

Connect with Alexia on LinkedIn here

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