a survey of operation and maintenance budgetary practices ... · cib2007-071 a survey of operation...

CIB2007-071

A Survey of Operation and Maintenance Budgetary Practices for

Commercial Buildings in Hong Kong – Preliminary Findings

Dr. Joseph H. K. Lai, Prof. Francis W. H. Yik

ABSTRACT Allocation of adequate resources for recurrent operation and maintenance (O&M) work is crucial to sustaining the performance of a building and hence its economic rent. Commercial building owners would desire to minimise O&M costs while striving to maximise rental income. This is, however, unachievable without proper budgeting and control of O&M work which is typically undertaken by a hybrid of in-house and outsourced resources. This paper reviews the budgeting principles and models in literature and reports the findings of a study investigating the budgeting and control practices through a series of face-to-face interviews with three different groups of O&M practitioners, namely those playing the role of building owner, building management company and contractor. The key pieces of information on which budgets are based, the budget estimation techniques, and the methods and processes used to control expenditure are analysed and discussed.

KEYWORDS: Operation and Maintenance; Budgetary Control; Commercial Buildings; Hong Kong 1.1 INTRODUCTION Commercial buildings, comprising primarily hotel, office and retail premises, represent a major proportion of the growing and ageing building stock in Hong Kong (RVD, 2006). To the owners of these buildings, it is

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always desirable to minimize O&M costs while striving for better service quality to attract tenants, thus increasing rental income. This has become apparent after the economic downturn in the late 90’s where many owners increasingly outsourced O&M work for their buildings (Yik & Lai, 2005). Rather than sole reliance on total outsourcing, the majority modes of outsourcing are ‘partial’, ‘selective’ or ‘bundled’, which involve a hybrid of in-house and external resources (Lai et al., 2004). In managing a wide range of building O&M work (e.g. air-conditioning, electrical installation, etc.), building owners typically employ a building management company to play the role of ‘managing contractor’ to supervise, coordinate and monitor the performance of various O&M contractors (Lai et al., 2004). Given the prevailing use of lump sum contracts without detailed and precise specification (Lai et al., 2006), it is uncertain whether the resources estimated by the three parties would be in congruent. Little problem would arise if the budgets of the owner, managing contractor and O&M contractor are in descending order. In the reverse case where the resources budgeted by the contractors are inadequate, the owner is unlikely to obtain the needed contract service. Resources for O&M work are often ill-budgeted (e.g. Horner et al., 1997). Because funding available is usually less than needed, maintenance works are often prioritised for execution (Shen & Spedding, 1998). But the problem of improper budgeting remains unresolved without understanding how O&M work is budgeted and controlled in practice. Many postal surveys investigated the budgeting practices in various sectors, with some covering a range of different industries including banks, hospitals, and companies of finance, service, life insurance, manufacturing, trading, transportation and utilities (Umaphthy, 1987); and some focussing on industrial companies (Puxty & Lyall, 1989), hotels and food service firms (Schmidgall & Ninemeier, 1989), lodging firms (Schmidgall et al., 1996), federal facilities (FFC, 1996), and hotels (Jones, 1998). There have been some survey studies on capital budgeting for building construction works (e.g. Lam et al., 2001) and some analysed building operating cost data obtained from other surveys (e.g. Macsporran & Tucker, 1996). Findings from studies which probe into the budgeting and control practices for O&M work in commercial buildings, however, are yet to be seen. This may be because collecting sensitive information about cost estimation and control mechanism is difficult. As in Merchant (1981), the respondents were advised that their companies had approved the conduction of the study before they were asked to provide data. The fact that no standardized guidelines on O&M budgeting and control procedures exist adds on to the unpopular discussion of the topic among the practitioners and their common reservation in expressing relevant opinions. The study reported in this paper aims to investigate the budgetary practices actually used by practitioners looking after O&M work for

CIB World Building Congress 2007 743

commercial buildings in Hong Kong. The following begins with a review of the information needed to facilitate O&M budgeting and the budgeting bases and models searched from literature. Then, the methodology and samples of the study are reported. The final part analyses the findings, followed by some preliminary conclusions. 2.1 INFORMATION FOR O&M BUDGETING Proper budgeting and control for O&M work should commence from formulating a clear and appropriate O&M policy, which is crucial for choosing a right strategy to implement the required work (RICS, 2000). To this end, O&M information such as relevant contract documents, condition survey records, statutory maintenance requirements, etc. (Wordsworth, 2001; Armstrong & Saville, 2005) should be taken into account when determining an O&M standard that fits in the building owner’s strategic objective, although the latter may vary from one building to another. Other than technical competence, practitioners should also possess adequate financial management knowledge in relation to building O&M. In Hong Kong, however, building O&M has not been a preferred career for many engineers. There has been no formal tertiary academic programme dedicated to producing building O&M practitioners (Mou, 1999). Although literatures on budgeting and budgetary control have long been available (Scott, 1970; BIM, 1972; Cave, 1973), they are not tailored for use in the building O&M regime. With the growth of the facilities management sector in the building industry in recent decades, there has been an increasing amount of handbooks and guidelines (e.g. Lewis, 1999; Cotts & Rondeau, 2004; DPW, 2006), which include O&M practitioners as part of their target readers. But the practices they recommended are not directly applicable in Hong Kong, for reasons such as differences between the rules on legal compliance, the ways in which O&M works are organized and the classifications of budgeted works. Whereas ICAC et al. (2003) was launched to provide guidance on how to prepare budgets and on what measures can be used to control their expenditure, its main purpose is to foster an anti-corruption culture in managing the finance of buildings. 2.2 BUDGETING BASES AND MODELS Searching from a wide spectrum of literature has revealed a number of different budgeting bases (Curran, 1975; 1999; Brimson & Antos, 1999; Moscato & Pollina, 1999; Schwartz & Mateo, 1999; Cotts & Rondeau, 2004), whose characteristics are summarized in Table 1.

Table 1 Characteristics of budgeting bases


Basis Characteristics Activity • Quantification of expected activities to reflect

management forecast of workload and financial and non-financial requirements to meet agreed strategic goals

• Three key elements must be present: type, quantity and cost of work to be done

Bracket • Complements conventional budgeting techniques to

overcome the inadequacy in dealing with difference between actual profit and target (i.e. business realities)

• By varying the same percentage of each element, the elements can then be ranked according to their impacts

Charge-back

• The facility department charges each operating division a rent for those services

• Each operating division may use the in-house services or procure them from external service providers

Expense/revenue

• Budget determined based on some defined relationship between the particular expense under consideration and revenue, frequently in terms of a ratio or a percentage

Flexible • Developed taking into account a relevant range over

which an budgeted activity is expected to fluctuate • Usually includes a separation of fixed and variable costs

over the relevant range

Historical • Takes into account the previous year’s budget and the actual results

• Budget for the projected period is adjusted, depending on the previous year’s results and on the expectations for the projected period

Zero • Budget is prepared from the ground up, as though it were

being prepared for the first time • Typically undertaken on a less regular basis, only for a

subset of responsibility centres at any one time, because its preparation involves considerable time and resources

3.1 INTERVIEWS AND DEMOGRAPHY OF SAMPLES Whether and to what extent the foregoing has been practised by O&M practitioners are to be revealed by empirical research. Grounded on the literature reviewed, a questionnaire was designed for use in face-to-face


interviews to probe into the actual budgeting and control practices of the practitioners. Comprising four parts, the first part of the questionnaire was to record the personal particulars of the interviewee. The second part enquired into the budgeting and control practice pertinent to one trade of outsourced O&M work for a representative building which the interviewee actively handled. The third part asked the interviewee to indicate his perceptions and experience in general about some attributes to proper budgeting and control. The final part contained a series of open-ended questions which allow the interviewee to liberally express his opinions and comments about budgetary practice.

The interviewees were randomly selected from members of the Building Services Operation and Maintenance Executives Society (BSOMES) and experienced O&M practitioners in Hong Kong with whom the authors had personal contacts. Before the interviews, the questionnaire was sent to the interviewees so as to pre-inform them its content and to allow them adequate time for retrieving the necessary record data.

The interview survey has been underway, with eight interviews completed. One interviewee was unable to provide some sensitive yet essential information. The findings reported here were drawn from the seven useful interviews, among which two interviewees are owner representatives, three come from building management companies and the remaining two are employees of O&M contractors. They on average have worked in the field for 15 years, altogether looking after 38 commercial buildings with an aggregate floor area of 871,200 m2. 4.1 BUDGETING IN PRACTICE None of the interviewees expressed that either a clear O&M policy or strategy had been in place for the buildings they handled. When preparing budget for O&M work, the information on which they often relied can be classified as historical, exogenous or forecasted. 4.1.1 Historical Information This group of information primarily includes previous budget and maintenance history. To the practitioners playing the role of building owner or management company, the amount of money approved for disbursing O&M expenses in the previous period is of great importance. No matter what levels of budget they drafted, they would always compare them with the previous budget. Their experiences tell that a budget larger than the preceding one can hardly get approved, unless it is justified by extensive substantiation which, practically, is time-consuming and unaffordable to most practitioners. An alternative way to get such ‘extra’ work funded is to defer and package them to become some improvement work (customarily


called as ‘capital work’ in their common practice). This kind of work can then be financed by the sinking fund drawn from the collected management fee over a certiain period (Loo, 1991). Obviously, the price for this improper practice is the inability to timely meet the real O&M needs.

To O&M contractors who are newly invited to bid for a particular work, they would normally assess the condition of the built facilities that the contract prescribes during a pre-tender site visit. As the interviewees pointed out, however, such assessment is rough, both because of the limited time allowed and the minimal time that they can afford. In consequence, they often resorted to ask the owner’s representative for the maintenance history, such as the recurrent consumption of spare parts (e.g. light tubes) and any burdensome work which is invisible from the explicit contract scope. The extent and accuracy of such information so obtained depend largely on the relationship between the owner representative and the tenderer. In contrast, the serving O&M contractor has been familiar with the plant performance and asset conditions, which are asymmetric information (Lai et al., 2006) unknown to fresh tenderers. 4.1.2 Exogenous Information Besides the portion of budget estimated by in-house staff, quotations prepared by contractors in respect of the outsourced work also form an essential part of the overall O&M budget. It is common practice to ask the serving contractors to provide quotations for the works that they have been undertaking. Unless the quoted amounts differ significantly from the extant contract sums or where there is great pressure to cut costs, they would normally be taken as the budget for that part of work.

For new items of O&M work, in addition to the serving contractor, the owner representative or building management personnel would typically call quotations from 2 to 3 more contractors. Any exceedingly high or low estimates would be discarded; the mean of the majority quotes would be regarded as reasonable. But because only preliminary specification of the work would be made available and the contractors are required to prepare the estimates within a short period during the budgeting exercise, it is risky that the seemingly reasonable estimate actually deviates from the needed budget.

Building expenditures are to be disbursed from management fee collected from building tenants (HKIR, 2005). Prediction of the receivable management fee and the control of its use, however, are in the hands of the leasing manager. Being a party exogenous from the O&M department, he often predetermined a ceiling for the O&M budget. For instance, if the receivable management fee is HK$6.0/sq.m and the ceiling for O&M expenses is 60% of the building expenditure, the O&M manager would


need to prepare his budget based on a maximum of HK$3.6/sq.m. The interviewees have long been accustomed to this practice. 4.1.3 Forecasted Information Turnover of tenants would result in the need to modify tenant premises and the associated services installations, e.g. merging two adjacent premises, thereby altering the affected part of the air-conditioning system. While the rate of tenant removal would be high during a down-turning market, the demand for modification work would be low so long as the vacated premises remain vacant. When the market recovers, the vacant premises would need to be modified to cater for new tenants. Such demand and the corresponding O&M resources needed, however, are difficult to predict.

It is common to set aside budgets for the so-called capital works (e.g. re-roofing, replacement of chillers, lift modernisation, etc.) to be executed following a planned programme separate from that of the routine O&M works. The amount of O&M works for installations which are due to be replaced would drop. For example, less would be spent for repairing a deteriorating chiller near its replacement date, but more energy cost would be incurred due to its declining energy efficiency. The interviewees, nevertheless, seldom carried out this kind of evaluation during budgeting. 4.1.4 Budgeting Bases and Methods To most of the interviewees, budgeting for O&M works had been an essential part of their regular work, but they were largely unaware of the basis on which it was proceeded. The interviewer had to explain to them the characteristics of various budgeting bases in Table 1 before collecting their responses.

Of the seven interviewees, one employed directly by the sole owner of a Grade C office building had not carried out any formal budgeting exercise and thus there was no basis for budgeting at all.

The other four interviewees, as pointed out earlier, largely followed the historical budgets when estimating O&M resources. As for major items (e.g. operational resources for a central chiller plant), two of them budgeted on an individual activity basis.

Another building management practitioner who also adopted activity-based budgeting considered his budget was made on an expense/revenue basis. But further discussion unveiled that what he regarded is simply the use of collected management fee (revenue) to fund O&M work (expenses), yet without a defined ratio between the two.

The two contractors indicated that they prepared their budgets on other bases. In fact, they estimated the costs for the contract works based on two key items. First, referring to the nature and complexity of work they


anticipated the required number of worker at various job ranks, followed by multiplying them by the corresponding market wage rates. Second, the costs for procuring the equipment or materials that the contract specified were estimated, mainly through oral quotations from suppliers. The total cost so estimated was then padded with a margin for overheads and profit, whose amount was adjusted to make the tender sum comparable with the contract sum of the same work in the preceding period. In case the latter was unknown, the margin was determined by speculation.

Budgeting on bracket or flexible basis, which is rather common in industries like manufacturing, was not used by the interviewees. It is not because the amount of O&M work is always certain, but because the quantity of work which could not be determined before contract commencement would normally be deferred for execution or covered by separate quotations later.

While some interviewees agreed with the merits of zero-based budgeting, they all considered this option impracticable, mainly because their already heavy workload did not permit them to afford the considerable time needed. 4.2 CONTROLLING EXPENDITURE 4.2.1 Procedures Governing Expenditure Only one practitioner who worked for a prestigious building owner indicated that expenditure of O&M budget was controlled by a set of documented procedures. There were no such procedures governing the building management practitioners; generally the accounting department of these practitioners issued variance reports every one to three months and they would need to explain the reasons for any expenditure exceeding plus or minus 10% of the budget.

The practice of the contractors in controlling expenditure was more loose. Without any interim variance reports during the contract period, the only mechanism which governed their expenditure was the tracking of purchase orders issued to their subcontractors. In case of budget deficit, usually at a later stage of the contract, it was common to delay payments to employees or subcontractors while exploring if cash received from other contracts can be used as temporary subsidy. 4.2.2 Measures for Settling Contract Payments The interviewees were given a list of measures used for settling contract payments and they were asked to indicate the extent of their


implementation according to an ordinal scale (i.e. 1 = no ; 2 = low ; 3 = fair ; 4 = high; 5 = extreme). The average ratings of their responses were listed in Table 2.

Table 2 Extent of measures used

Means Rating (r) Rank Verify completed work 4.00 1 Witness work execution 3.00 2 Log staff attendance 2.86 3 Verify staff attendance 2.86 3 Verify material delivered on-site 2.71 5 Verify purchase order 2.29 6

Verification of the completed works was implemented to a high extent (r = 4.00), followed by a fair extent (r = 3.00) of witnessing the works during their execution. While there was logging and verification of the contract staff attendance, the extent of their implementation was fairly low (r = 2.86). The extents of verifying material delivered on-site and checking purchase order were even lower.

These findings show that when settling contract payments, larger emphasis was placed on verifying the outcome than on the input or process of the work. On the one hand, this outcome-based management principle would help economise on the contract monitoring cost. On the other hand, it would be less able to detect unsatisfactory material or workmanship during the work processes. The risk of accepting substandard works hidden from sight upon their completion and thus the cost for rectifying latent defects would be potentially high. 4.2.3 Measures Conducive to Controlling Work Delivery Apart from using various measures to ascertain the completed works before settling their payments, there are other measures that can be incorporated in the contract document to help control the delivery of work by the contractors. They include incentive, surety bond, retention money, liquidated damages, defects liability period, and warranty period.

Among the seven sampled contracts, each of which selected by the interviewees as representative, none of them was incorporated with the provision of incentive or surety bond (Table 3). Incentive is often used in circumstances where the employer desires the contract to act in a particular way, e.g. early completion of work, which nonetheless is rare in the O&M contract regime. As the contract sum of individual O&M contract or subcontract works is typically not substantial, requiring the contractor to


secure surety bond could hardly be imposed as the cost incurred will eventually be borne by the client.

Table 3 Measures incorporated in O&M contracts

Measures Incorporated in contract No Yes Incentive 7 0 Surety Bond 7 0 Retention money 5 2 Liquidated damages 5 2 Defects liability period 4 3 Warranty period 2 5

Retention money, which would be released to the contractor upon satisfactory discharge of the whole of his contractual obligation, was not commonly incorporated in the contracts. The main reason is, for O&M works whose individual contract sums are relatively small, the amount of money that can be retained (5 to 10% of contract sum) and thus the effect on controlling the contractor performance is minimal. The same reason applies for the rare incorporation of liquidated damages (5 to 10% of contract sum) in the sampled contracts.

Contracts incorporated with defects liability period and warrenty period, which ranged between 6 to 12 months and 3 to 12 months respectivley, were common. Both of them, however, are inapplicable for services (e.g. inspection) which are hard to verify after their completion. It is also uncommon to impose them under O&M contracts with short contract period (e.g. 6 to 12 months), in contrast to construction contracts spanning over years. 5.1 CONCLUSIONS Many of the budgeting bases and models suggested in literature were not commonly used by the O&M practitioners in Hong Kong. The methods and procedures actually adopted were loose and variable, implying a high risk of mismatch between the needed O&M resources and the available budget.

While individual O&M works are relativley small, the fact that they recur throughout the building life should warrent putting more effort to their proper budgeting and control. When more interviews are completed, the opinions and experience of the three groups of O&M practitioners will be examined in more detail, so as to make clearer the less than satisfactory practices and to find ways for their improvement.


6.1 ACKNOWLEDGEMENT The work reported was supported by the Internal Competitive Research Grant (G-YF09) of the Hong Kong Polytechnic University. 7.1 REFERENCES Armstrong, J. and Saville, A. (2005), Managing your building services, The Chartered Institution of Building Services Engineers. Barco, A.L. (1994), Budgeting for Facility Repair and Maintenance, Journal of Management in Engineering, Vol. 10, No. 4, pp. 28-34. BIM (1972), Budgetary control for the smaller company, Management

Guide No. 4, British Institute of Management. Brimson, J.A. and Antos, J.J. (1999), Activity-based budgeting, in Rachlin, R.(ed.), Handbook of Budgeting, John Wiley & Sons, Inc., pp. 31.1-31.20. Cave, S.R. (1973), Budgetary control and standard costing, Gee and Company (Publishers) Limited. Cotts, D.G. and Rondeau, E.P. (2004), The Facility Manager’s Guide to Finance and Budgeting, American Management Association. Curran, M.W. (1975), How Bracket Budgeting Helps Managers Cope with Uncertainty (Part 1), Management Review, April, pp. 4-15. Curran, M.W. (1999), Bracket budgeting, in Rachlin, R. (ed.), Handbook of Budgeting, John Wiley & Sons, Inc., pp. 28.1-28.25. DPW (2006), Asset management policies & systems, Department of Public Works, Queensland Government, available at: http://www.build.qld.gov.au/amps/amps02.asp FFC (1996), Budgeting for Facilities Maintenance and Repair Activities, Federal Facilities Council (FFC) - Standing Committee on Operations and Maintenance, National Academy Press. HKIR (2005), Professional Practice of Property Management, Hong Kong Institute of Real Estate, Commercial Press (Hong Kong). Horner, R.M.W., El-Haram, M.A., Munns, A.K. (1997), Building maintenance strategy: a new management approach, Journal of Quality

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Hong Kong SAR. Jones, T.A. (1998), UK hotel operators use of budgetary procedures,


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2004, pp. 357-367. Lai, J.H.K., Yik, F.W.H. and Jones, P. (2006), Critical contractual issues of outsourced operation and maintenance service for commercial buildings, International Journal of Service Industry Management, Vol. 17 No. 4, pp. 320-343. Lam, K.C., Runeson, G., Ng, S.T., Hu, T.S., Cheung, S.O. and Deng, Z.M. (2001), Captial budget planning practices of building contractors in Hong Kong, Construction Management and Economics, 19, 569-576. Lewis, B.T. (1999), Facility Manager’s Operation and Maintenance Handbook, McGraw-Hill. Loo, F.K. (1991), A Guide to Effective Property Management in Hong Kong, Hong Kong University Press. Macsporran, C. and Tucker, S.N. (1996), Target budget levels for building operating costs, Construction Management and Economics, 14, 103-119. Merchant, K.A. (1981), The Design of the Corporate Budgeting System: Influences on Managerial Behavior and Performance, The Accounting Review, Vol. 56, No. 4, pp. 813-829. Moscato, D.R. and Pollina, T. (1999), Computer applications in budgeting,

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Mou, C.S. (1999), Maintenance: Preventive or Predictive?, Asia Engineer, September, pp. 18-21. Ottoman, G.R., Nixon, W.B., Lofgren, S.T. (1999), Budgeting for facility maintenance and repair. I: Methods and models, Journal of management in Engineering, Vol. 15, No. 4, pp. 71-83. Puxty, A.G. and Lyall, D. (1989), Cost control into the 1990s: a survey of standard costing and budgeting practices in the UK, The Chartered Institute of Management Accountants. RICS (2000), Building Maintenance: Strategy, Planning and Procurement, RICS Books. RVD (2006), Hong Kong Property Review, Rating and Valuation Department, Hong Kong SAR. Scott, J.A. (1970), Budgetary control and standard costs, Pitman Publishing. Schmidgall, R.S. and Ninemeier, J. (1989), Budgeting practices in lodging And food service chains: an analysis and comparison, International Journal of Hospitality Management, Vol. 8, No. 1, pp. 35-41. Schmidgall, R.S., Borchgrevink, C.P. and Zahl-Begnum, O.H. (1996),


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& Information, 26(3), 169-180. Then, S.S. (1990), A strategic approach to budgeting for built asset management, Proceedings of Facilities Management International – Managing the Maintenance Budget, April 1990, Glasgow. Umapathy, S. (1987), Current Budgeting Practices in U.S. Industry,

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