The Asset Management Review

The Asset Management Review The Asset Management Review Fourth Edition Editor Paul Dickson Law Business Research

The Asset Management Review The Asset Management Review Reproduced with permission from Law Business Research Ltd. This article was first published in The Asset Management Review - Edition 4 (published in September 2015 editor Paul Dickson) For further information please email [email protected]

The Asset Management Review Fourth Edition Editor Paul Dickson Law Business Research Ltd

PUBLISHER Gideon Roberton SENIOR BUSINESS DEVELOPMENT MANAGER Nick Barette SENIOR ACCOUNT MANAGERS Katherine Jablonowska, Thomas Lee, Felicity Bown, Joel Woods ACCOUNT MANAGER Jessica Parsons PUBLISHING MANAGER Lucy Brewer MARKETING ASSISTANT Rebecca Mogridge EDITORIAL ASSISTANT Sophie Arkell HEAD OF PRODUCTION Adam Myers PRODUCTION EDITOR Anne Borthwick SUBEDITOR Charlotte Stretch MANAGING DIRECTOR Richard Davey Published in the United Kingdom by Law Business Research Ltd, London 87 Lancaster Road, London, W11 1QQ, UK 2015 Law Business Research Ltd No photocopying: copyright licences do not apply. The information provided in this publication is general and may not apply in a specific situation, nor does it necessarily represent the views of authors firms or their clients. Legal advice should always be sought before taking any legal action based on the information provided. The publishers accept no responsibility for any acts or omissions contained herein. Although the information provided is accurate as of September 2015, be advised that this is a developing area. Enquiries concerning reproduction should be sent to Law Business Research, at the address above. Enquiries concerning editorial content should be directed to the Publisher [email protected] ISBN 978-1-909830-68-4 Printed in Great Britain by Encompass Print Solutions, Derbyshire Tel: 0844 2480 112





CONTENTS Editor's Preface...vii Paul Dickson Chapter 1 EUROPEAN OVERVIEW... 1 Edward Burrows Chapter 2 AUSTRALIA... 40 Lucinda McCann, Nikki Bentley and Vinod Kumar Chapter 3 BELGIUM... 55 Thierry Tilquin, Tom Van Dyck, Greet Bontinck and Steven Peeters Chapter 4 BERMUDA... 68 Sarah Demerling and Sally Penrose Chapter 5 BRAZIL... 81 Fernando J Prado Ferreira and José Paulo Pimentel Duarte Chapter 6 BRITISH VIRGIN ISLANDS... 95 Jeffrey Kirk and David Mathews Chapter 7 CANADA... 104 Alix d Anglejan-Chatillon and Jeffrey Elliott Chapter 8 CAYMAN ISLANDS... 121 Nicholas Butcher, Anna Goubault and Krista-Lynn Wight Chapter 9 CHINA... 136 Richard Guo and Zhen Chen iii

Contents Chapter 10 FINLAND... 152 Janne Lauha, Leena Romppainen and Hannu Huotilainen Chapter 11 FRANCE... 166 Arnaud Pince Chapter 12 GERMANY... 180 Thomas Paul and Christian Schmies Chapter 13 HONG KONG... 193 Jason Webber, Peter Lake and Ben Heron Chapter 14 INDIA... 211 Ashwath Rau, Ganesh Rao and Aditya Jha Chapter 15 IRELAND... 224 Kevin Murphy, Elizabeth Bothwell, David O Shea, David Kilty and Sarah McCague Chapter 16 ISLE OF MAN... 238 Simon Harding and Katherine Johnson Chapter 17 ITALY... 250 Giuseppe Rumi, Daniela Runggaldier, Riccardo Ubaldini and Michele Dimonte Chapter 18 JAPAN... 267 Yasuzo Takeno and Fumiharu Hiromoto Chapter 19 LUXEMBOURG... 286 Jacques Elvinger, Olivier Gaston-Braud and Joachim Kuske Chapter 20 NETHERLANDS... 304 Lotte Boon and Joost Steenhuis Chapter 21 NIGERIA... 316 Dan Agbor, Folake Elias-Adebowale and Christine Sijuwade iv

Contents Chapter 22 NORWAY... 331 Peter Hammerich and Markus Heistad Chapter 23 PORTUGAL... 347 Carlos Costa Andrade, Marta Pontes, Diogo Tavares, Hélder Santos Correia and Gerard Everaert Chapter 24 RUSSIA... 361 Pavel Karpunin, Dmitry Churin and Anastasia Fomicheva Chapter 25 SAUDI ARABIA... 376 Nabil A Issa and James Stull Chapter 26 SINGAPORE... 388 Stefanie Yuen Thio and Yvonne Lee Chapter 27 SOUTH AFRICA... 399 Johan Loubser and Magda Snyckers Chapter 28 SPAIN... 416 Juan Carlos Machuca Siguero and Joaquín García-Cazorla Taboada Chapter 29 SWEDEN... 438 Emil Boström and Jonas Andersson Chapter 30 SWITZERLAND... 451 Shelby R du Pasquier and Maria Chiriaeva Chapter 31 UNITED ARAB EMIRATES... 467 James Stull and Macky O Sullivan Chapter 32 UNITED KINGDOM... 476 Paul Dickson Chapter 33 UNITED STATES... 517 Jason E Brown, Leigh R Fraser and John M Loder v

Contents Appendix 1 ABOUT THE AUTHORS... 535 Appendix 2 CONTRIBUTING LAW FIRMS CONTACT DETAILS... 559 vi

EDITOR S PREFACE Following several challenging years in the wake of the global financial crisis of 2007 2008, recent years have seen a more sustained economic recovery take hold. However, despite significant improvements in the global economic landscape, 2014 was marked by significant geopolitical events, which have taken their toll on financial markets outside the US and Japan. In the UK, both the Scottish referendum and predictions of a close general election outcome in May 2015 created an uncertain political environment. At a European level, markets have been faced with continuing tensions in Eastern Europe, as well as the ongoing sovereign debt issues, with the Greek crisis featuring heavily in news headlines over the past 12 months. The collapse of oil prices, the spread of the Ebola virus in West Africa and the ongoing conflict in the Middle East have also had a significant impact on the global economy. Nevertheless, the importance of the asset management industry continues to grow. Nowhere is this truer than in the context of pensions, as the global population becomes larger, older and richer, and government initiatives to encourage independent pension provision continue. By way of example in the UK, changes to the rules governing what retirees can do with their pension benefits look set to open up a new section of the market to discretionary managers and product providers. The activities of the financial services industry remain squarely in the public and regulatory eye, and the consequences of this focus are manifest in ongoing regulatory attention around the globe. Regulators are continuing to seek to address perceived systemic risks and preserve market stability through regulation. In Europe, major changes to the regulatory landscape were introduced by the Alternative Investment Fund Managers Directive, which has applied in full since July 2014, and this trend is set to continue in other areas of the asset management industry with the implementation of changes to the UCITS regime and the revised Markets in Financial Instruments package. In the UK, the Financial Conduct Authority has announced plans for a market study on the asset management industry and the charges it levies on investors. vii

Editor s Preface It is not only regulators who continue to place additional demands on the financial services industry in the wake of the financial crisis; the need to rebuild trust has led investors to call for greater transparency around investments and risk management from those managing their funds. Investors and regulators demands for greater clarity on fees and commissions charged by fund managers for services provided also remain a constant presence. This continues to be a period of change and uncertainty for the asset management industry, as funds and managers act to comply with regulatory developments and investor requirements and adapt to the changing geopolitical landscape. Despite the challenges outlined above, confidence has begun to return across a number of areas, buoyed by increasingly positive assessments of the global economic outlook, which raises the prospect of increased investment and returns. Although the challenges of regulatory scrutiny and difficult market conditions remain, a return of risk appetite has also evidenced itself. The industry is not in the clear but, prone as it is to innovation and ingenuity, it seems well placed to navigate this challenging and rapidly shifting environment. The publication of the fourth edition of The Asset Management Review is a significant achievement, which would not have been possible without the involvement of the many lawyers and law firms who have contributed their time, knowledge and experience to the book. I would also like to thank Gideon Roberton and his team at Law Business Research for all their efforts in bringing this edition into being. The world of asset management is increasingly complex, but it is hoped that the fourth edition of The Asset Management Review will a useful and practical companion as we face the challenges and opportunities of the coming year. Paul Dickson Slaughter and May London September 2015 viii

Chapter 30 SWITZERLAND Shelby R du Pasquier and Maria Chiriaeva 1 I OVERVIEW OF RECENT ACTIVITY With its long tradition of banking and finance, Switzerland is one of the leaders at the international level in the asset management industry. Swiss asset management constitutes one of the main pillars of the Swiss financial centre. The asset management industry in Switzerland is heterogeneous and applies different business models. Large banking institutions active in wealth management (private banking) coexist with a number of smaller niche players. Independent asset managers represent the lion s share of the para-banking sector within the Swiss financial industry, with a limited level of regulatory oversight for the time being (see Section V.i, infra, on the future regulatory developments in this respect). In recent years, a number of alternative asset managers have decided to relocate to Switzerland. Current challenges to the asset management industry in Switzerland include a wave of new regulatory activity spurred by the 2008 financial crisis and the regulatory developments occurring at the EU level. The Swiss legal and regulatory framework is being adjusted on an ongoing basis to ensure its euro-compatibility to keep it in line with international standards and to enhance the protection granted to investors. II GENERAL INTRODUCTION TO THE REGULATORY FRAMEWORK Switzerland does not have a comprehensive licence for all financial services providers. Certain financial activities do require licences, whereas others can be conducted on a largely unregulated basis. The following financial services providers are subject to prior licensing and ongoing prudential supervision by the Swiss Financial Market Supervisory 1 Shelby R du Pasquier is a partner and Maria Chiriaeva is an associate at Lenz & Staehelin. 451

Switzerland Authority (FINMA): banks, insurance companies, securities dealers, fund distributors, fund administration companies and managers of collective investment schemes (CISs). Switzerland is not a Member State of the EU; therefore, EU rules and regulations do not apply directly to financial services activities conducted in Switzerland. With the exception of general rules that apply to all asset managers in Switzerland (see Section II.i, infra), the conduct of asset management activities is subject to specific regulations only where such services are rendered in connection with a CIS (see Section II.ii, infra) or involve the trading of securities (see Section II.iii, infra) or the management of Swiss pension funds assets (see Section II.iv, infra). In light of its practical relevance, we further set out an overview of the rules applicable to the distribution, in or from Switzerland, of interests in a non-swiss CIS (see Section II.v, infra). i Regulation of asset management in general Direct regulation under the Swiss Anti-Money Laundering Act (AMLA) Contrary to the situation prevailing in a number of other jurisdictions, asset management activities are not, as a matter of principle, subject to prudential supervision in Switzerland unless these activities are conducted in connection with a Swiss or non-swiss CIS (see Section II.ii, infra), the asset manager is characterised as a securities dealer (see Section II.iii, infra) or he or she manages assets of Swiss pension funds (see Section II.iv, infra). That said, asset managers will in all instances qualify as financial intermediaries within the meaning of Article 2(3) of AMLA and, as such, be subject to the Swiss regulations against money laundering, which are based on the standards adopted by the Financial Action Task Force on Money Laundering (FATF). In particular, AMLA requires that the relevant financial intermediary registers with, and is subject to the supervision of a self-regulatory body recognised by FINMA or is supervised by FINMA directly (Article 12(c) AMLA). The duties imposed upon the financial intermediary under AMLA are essentially know-your-customer rules and procedures, as well as certain organisational requirements (e.g., internal controls, documentation and continuing education) (Article 3 et seq. AMLA). In addition, financial intermediaries are required to report to the regulatory body and to immediately block the assets for a period of up to five days in the event of suspicion of criminal activity. Such reporting duty presupposes that the financial intermediary is aware of, or has reasonable suspicion, as regards the criminal origin of the assets involved (Articles 9 and 10 AMLA). In this context, the regulatory body is also entitled to request information from third-party financial intermediaries that appear to be involved in the transaction or business relationship that triggered the reporting by another financial intermediary. A financial intermediary may incur a criminal liability, should it fail to comply with these duties. Between 2013 and 2014, the government worked on a revision of AMLA with a view to adapting it to the revised FATF recommendations and to addressing certain shortcomings that were identified during Switzerland s evaluations by the FATF. The Swiss parliament adopted the final draft on 12 December 2014. The entry into force of the revised AMLA and the other relevant pieces of legislation will take place in two stages, first on 1 July 2015 (see Section III.ii, infra, on the revision of the Collective Investment Schemes Act (CISA)) and then on 1 January 2016. 452

Switzerland As per the revised AMLA, from January 2016 financial intermediaries will have to implement a two-stage mechanism after the reporting of suspicions to the regulatory body. First, they will have to monitor the concerned account for a period of up to 20 days during the analysis of the case by the regulatory body (so as to suspend any transaction that may result in preventing the confiscation of the concerned asset). As a second step, if the case is transferred to a criminal prosecution authority, the financial intermediaries will have to implement a full freeze on the account for up to five days until a decision to maintain the freeze is made by the criminal authority. Indirect regulation under FINMA Circular 01/2009 Furthermore, FINMA has defined certain requirements (outlined in the revised FINMA Circular 01/2009, which entered into force on 1 July 2013) that asset managers are required to comply with in order for such managers and their clients to benefit from certain exemptions under the (CISA see Section II.v, infra). The duty to enforce the provisions of FINMA Circular 01/2009 lies with the self-regulatory bodies, which are in turn supervised by FINMA. As a result, it is generally considered that asset managers are only indirectly regulated in Switzerland. Inter alia, FINMA Circular 01/2009 imposes on asset managers certain duties of care, loyalty and information in relation to their clients, as well as a duty to comply with a fit and proper test. In addition, FINMA Circular 01/2009 provides for a requirement to specify in the asset management agreement entered into with clients the terms of the remuneration of the asset manager. 2 FINMA Circular 01/2009 also regulates the third-party inducements (retrocessions) that may be received by asset managers. From a Swiss law perspective, the term retrocessions generally refers to certain forms of fee payments agreed upon between financial intermediaries (e.g., banks, securities dealers, asset managers). Typically, in the field of private wealth management, a custodian bank may pay certain retrocessions to an external asset manager who manages client assets deposited with the custodian bank. In a decision rendered on 30 October 2012, 3 the Swiss Supreme Court ruled that the distribution fees that the promoter of a financial product pays to the distributor could be characterised as retrocessions, and therefore be subject to the legal regime set out below (for the same topic within the context of the distribution of CISs, see SFAMA guidelines on distribution and transparency below). 2 Certain professional organisations also limit the level of compensation of asset managers. For instance, the Code of Conduct issued by the Swiss Association of Asset Managers sets out a maximum amount of management fees corresponding to 1.5 per cent per year calculated on the basis of the net asset value of managed assets, or performance fees of a maximum 20 per cent of the net capital increase (i.e., the increase in value taking into account deposits and withdrawals in addition to any unrealised losses). If both above-mentioned systems of fees are combined, management fees are capped at 1 per cent per year and the performance fees to a maximum of 10 per cent. 3 Decision of the Swiss Supreme Court of 30 October 2012 and published in the Official Court Reporter under No. ATF 138 III 755. 453

Switzerland In a landmark decision rendered on 22 March 2006 4 (confirmed in subsequent decisions), the Swiss Supreme Court held that retrocessions are subject to a statutory restitution duty and are, as a matter of principle, payable to the client of the receiving financial intermediary. Nonetheless, according to the Court, an arrangement whereby the client agrees that a financial intermediary may retain retrocessions received from third parties is valid, provided the client was duly informed of the existence and calculation formula of such retrocessions, and the client expressly waived his or her statutory restitution claim. As a result of this case law, a Swiss financial intermediary (such as an asset manager) intending to retain retrocessions received from third parties should ensure that the contractual documentation governing its client relationships meets the requirements set forth by the Swiss Supreme Court. In this context, the level of information (ex ante disclosure) that needs to be provided to clients is set forth in FINMA Circular 01/2009 and in the guidelines of the relevant professional organisations. Asset managers must typically advise their customers of any conflicts of interest that might arise as a result of accepting third-party inducements. According to the revised FINMA Circular 01/2009, they are to inform their clients of the calculation parameters, as well as of the spread of inducements they receive or might receive from third parties. In doing so, the information provided must differentiate between various product classes, insofar as this is possible. Upon a client s request, asset managers must also disclose the amount of any third-party inducements already received by them (ex post reporting). The revised FINMA Circular 01/2009 further requires that asset managers establish a client risk profile to cover the client s experience and knowledge in the financial field, risk appetite (subjective criteria) and risk capacity (objective criteria); and cover in their asset management mandate the investment objectives of the client based on this risk profile. These amendments were essentially triggered by the 30 October 2012 decision as well as the CISA revision. ii Regulation of CIS managers In the wake of the adoption of the EU Alternative Investment Fund Managers Directive (AIFMD), the CISA has been amended to ensure the euro-compatibility of the Swiss regulatory framework. One of the purposes of the CISA revision was to ensure that Swiss asset managers are in a position to continue to manage the assets of CISs that fall within the ambit of the AIFMD. Pursuant to the revised CISA (which entered into force on 1 March 2013), asset managers of both Swiss and non-swiss CISs must obtain a licence from FINMA. That said, the revised CISA contains a de minimis rule, according to which asset managers of non-swiss CISs whose investors are qualified investors (as defined in the revised CISA: see Section II.v, infra) are not regulated if they satisfy one of the following requirements: a the assets under management, including those resulting from the use of leverage, do not exceed 100 million Swiss francs; 4 Decision of the Swiss Supreme Court of 22 March 2006 and published in the Official Court Reporter under No. ATF 132 III 460. 454

Switzerland b c the assets under management do not exceed 500 million Swiss francs, and the CISs are unleveraged and closed-ended for a five-year period; 5 or the investors are exclusively group companies. According to the revised FINMA Ordinance on Collective Investment Schemes, which entered into force on 1 January 2015, assets whose management is entrusted to third-party managers are to be included in the calculation of the above thresholds. The value of the assets under management is also to be determined for each collective investment scheme in light of the valuation rules provided in the legislation of the home jurisdiction of the CIS. An asset manager of a non-swiss CIS that is exempt under the de minimis rule may, however, opt in under the revised CISA and apply for a FINMA licence, provided that its registered office is in Switzerland, and Swiss law or the applicable foreign law requires such regulated status for the management of the assets of the CIS. One important novelty of the revised CISA is the possibility for a non-swiss asset manager to operate in Switzerland as a branch for both Swiss and non-swiss CISs. The authorisation of a branch is, however, subject to the following cumulative requirements: a the non-swiss asset manager is subject to adequate supervision by its home regulator; b the non-swiss asset manager has adequate organisation, sufficient financial resources, as well as competent staff to operate a branch in Switzerland; and c a cooperation agreement is in place between FINMA and the non-swiss asset manager s home regulator. On 3 December 2012, FINMA announced that it had reached an agreement in principle with the European Securities and Markets Authority (ESMA), acting on behalf of the national supervisory authorities of the EU Member States, as regards a model cooperation agreement. On 16 July 2013, FINMA announced that this agreement with ESMA is to be supplemented by bilateral agreements with each national supervisory authority in the EU and in the European Economic Area. These bilateral agreements entered into force on 22 July 2013. Cooperation includes the exchange of information, cross-border on-site visits and mutual assistance in the enforcement of the respective supervisory laws, namely the AIFMD and the CISA, and covers the activities of Swiss alternative investment fund managers who distribute or manage alternative investment funds in the EU, as well as the European alternative investment fund managers who manage them or distribute them in Switzerland to qualified investors (as defined in the revised CISA: see Section II.v, infra). As a consequence of the above-mentioned AMLA revision (see Section II.i, supra), in June 2015, FINMA also revised its Ordinance on Money Laundering (AMLO-FINMA). According to the revised AMLO-FINMA, which will enter into force on 1 January 2016, asset managers of foreign CISs will benefit from a certain relaxation 5 In its annual report 2014, FINMA clarified that, for the purposes of this calculation, the fact that the CISs are invested in target funds or other investments is not relevant. 455

Switzerland of their due diligence requirements. Thus, the identification of the subscriber and the beneficial owner will not be required in the event that the foreign CIS or its investment management company are subject to adequate supervision in terms of AMLA and counter-terrorist financing, and the amount invested by the subscriber does not exceed 25,000 Swiss francs. iii Regulation of professional securities trading Depending upon the structure of their activities and of their client relationships, certain Swiss asset managers could fall within the ambit of the Swiss regulatory framework governing securities traders. Professional trading in securities as a principal (either for own account or on behalf of clients) is, subject to certain exceptions, a regulated activity under the Swiss Federal Act on Stock Exchanges and Securities Trading (SESTA). The concept of a securities dealer is defined in Article 2(d) SESTA as any person or entity who: [ ] purchases and sells securities in a professional capacity on the secondary market, either for its own account with the intent of reselling them within a short period of time or for the account of third parties, or makes public offers of securities to the public on the primary market, or creates derivatives and offers them to the public. The Swiss regulatory definition of securities dealer covers five types of trading activities, which are detailed in Article 3 of the Swiss Federal Ordinance on Stock Exchanges and Securities Trading and may be summarised as follows: a trading in securities as a principal on a short-term basis (own-account dealer); b underwriting and public offering on the primary market of securities issued by third parties (issuing house); c issuance and public offering on the primary market of derivatives as a principal or as an agent (derivative supplier); d trading in securities as a principal on a short-term basis, and offering sale or purchase prices in certain securities either permanently or upon request (market maker); and e trading in securities as an agent for clients, and either holding accounts for the clients or holding securities in safe custody for the account of clients, either directly or with third parties (securities dealer operating for the account of clients). Swiss securities dealers are subject to FINMA supervision, and are required to comply with organisational, conduct of business and prudential requirements broadly comparable with those applicable to Swiss banks. As a rule, asset managers or investment advisers that manage the assets of third parties on the basis of powers of attorney (i.e., who are acting as agent) are not characterised as securities dealers for the purpose of the SESTA and are, as things stand, only regulated under AMLA (see Section II.i, supra). iv Regulation of Swiss pension fund asset managers As of 1 January 2014, Swiss pension funds may only appoint as external asset managers financial intermediaries that are subject to official supervision in Switzerland (or abroad). 456

Switzerland Swiss banks and securities dealers were not affected by this change, as they were already subject to FINMA supervision. These supervised financial intermediaries were therefore entitled to continue to act as external asset managers of Swiss pension funds after 1 January 2014. Unregulated Swiss-based asset managers (i.e., independent asset managers) that intended to manage, or to continue to manage, assets of Swiss pension funds after 1 January 2014 have had to register and apply for a provisional licence with the Swiss Supervisory Commission for Pension Funds (Commission). In February 2014, the guidelines of the Commission on the issuance of licences to asset managers of Swiss pension funds (Guidelines) entered into force. The Guidelines provide that unregulated Swiss-based asset managers or regulated Swiss-based distributors of CISs (which do not, according to the Guidelines, benefit from the above dispensation) intending to manage assets of Swiss pension funds must apply for a three-year licence. This should be a temporary solution, inasmuch as independent asset managers are likely to be subject to regulatory supervision in the near future, regardless of whether or not they manage pension funds, following the enactment of the reform summarised under Section V, infra. v Regulatory framework applicable to the distribution of interests in non-swiss CISs The regulatory concept of distribution The entry into force of the revised CISA on 1 March 2013 resulted in the replacement of the long-established concept of public offering with the concept of distribution of CISs. Any offer or advertisement for a CIS that is not exclusively directed towards regulated financial intermediaries (e.g., banks, insurance companies, securities dealers, fund administration companies, asset managers of CISs and central banks) is now construed as distribution. Distribution, irrespective of whether being public or private, is regulated under the revised CISA. It is important to note that the revised CISA excludes the following four situations from the definition of distribution. The provision of information on or the offer of interests in non-swiss CISs are not deemed to constitute a distribution if they take place: a at the investor s request in the context of a long-term and remunerated advisory agreement or an execution-only relationship with a regulated financial intermediary (e.g., banks, securities dealers, fund administration companies, asset managers of CISs) or with an independent asset manager (subject to certain conditions); b upon the sole request of the investor in relation to a specific fund, and without any intervention or initial contact made by the financial intermediary (reverse solicitation); c within the context of a written discretionary asset management agreement entered into by the investor with a regulated financial intermediary or with an independent asset manager (subject to certain conditions); or d through the publication of prices, net asset values and tax data by regulated financial intermediaries. 457

Switzerland Following the CISA revision, FINMA revised its implementing FINMA Circular 09/2013 on the distribution of CISs, which entered into force on 1 October 2013. This Circular aims at clarifying the concept of distribution and, in particular, the concept of qualified investors (see Qualified investors below). The Swiss Funds and Asset Management Association (SFAMA) published revised Guidelines on the distribution of CISs whose entry into force took place on 1 July 2014. These Guidelines impose certain duties upon distributors and promoters of CISs, and provide for minimum standard provisions to be included in distribution agreements (for further details, see SFAMA guidelines on distribution and transparency below). Finally, the Guidelines of the Swiss Bankers Association on protocol requirements under Article 24 (3) CISA are also of relevance for the distribution of CISs. According to these Guidelines, distributors must record in writing the client s needs and document their recommendations made in view of the subscription to a CIS. Although FINMA initially recognised these Guidelines as minimum standard for a period of up two years (until 31 December 2015), these will continue to apply to all distributors until the entry into force of the future Federal Financial Services Act (FinSA) (see Section V.i, infra). Qualified investors The concept of qualified investor is another important regulatory concept in the context of the distribution of interests in non-swiss CISs. The revised CISA narrows the definition of qualified investors as follows: a Regulated qualified investors: regulated financial intermediaries, including banks, securities dealers, fund administration companies and managers of CISs, as well as central banks; and regulated insurance institutions. b Unregulated qualified investors: public entities and retirement benefit institutions (pension funds) with professional treasury management (this concept presupposes that the entity has at least one qualified professional in charge of the management of its financial assets); companies with professional treasury management; high-net-worth individuals (HNWIs) and private investment structures created for them, provided they have declared in writing that they wish to be deemed qualified investors (subject to certain conditions, such as minimum financial assets and technical competences) (opt-in declaration); and investors who have concluded a written discretionary asset management agreement with a regulated financial intermediary or with an independent asset manager (subject to certain conditions), provided that they do not exercise their right to opt-out of the qualified investors status. The latest revision of the Collective Investment Schemes Ordinance, which entered into force on 1 January 2015, clarified that private investment structures created for HNWIs may qualify as qualified investors. FINMA clarified in its Circular 09/2013 that asset managers may be treated as qualified investors subject to certain conditions, and provided that they undertake in writing that any information or materials in relation to the CIS be solely used for 458

Switzerland the benefit of qualified investors. Such written undertaking must be obtained from the asset manager before any provision of information on the CIS, as such discussion may otherwise be deemed to constitute an unauthorised distribution activity targeting non-qualified investors. It should be noted, however, that FINMA Circular 09/2013 does not address the issue of asset managers based outside Switzerland. The characterisation of an investor as being qualified has a bearing on the regulatory restrictions applicable to the distribution of interests in non-swiss CISs. The regulatory situation under the revised CISA can be summarised as follows. Distribution of non-swiss CISs to non-qualified investors The offering documentation of non-swiss CISs distributed to non-qualified investors must be approved by FINMA. Regular filing, notification and publication duties apply to the CIS, which must appoint a Swiss representative and paying agent. Additionally, the revised CISA requires the entering into of cooperation agreements between FINMA and the relevant foreign supervisory authorities. Any Swiss-based financial intermediary that distributes non-swiss CISs to non-qualified investors must be licensed as a distributor by FINMA. In addition, all distributors involved in the distribution of the CIS to non-qualified investors in Switzerland must enter into a written, Swiss law-governed distribution agreement with the Swiss representative, based on the requirements of the SFAMA Guidelines on distribution of CISs and its template distribution agreement. Distribution of non-swiss CISs to qualified investors The offering documentation of non-swiss CISs distributed to qualified investors is not subject to approval by FINMA, but a Swiss representative, as well as a paying agent, must be appointed by the CIS. Any Swiss-based financial intermediary that distributes non-swiss CISs to qualified investors must be licensed as a distributor by FINMA. By contrast, non-swiss financial intermediaries that are regulated in their home country may conduct distribution activities in connection with qualified investors, provided the foreign supervision is deemed appropriate by FINMA (i.e., their foreign regulatory status allows them to distribute CISs in their own jurisdiction). This carve-out could, for example, apply to the (regulated) non-swiss asset manager of a non-swiss CIS intending to distribute interests to certain qualified investors in Switzerland (without appointing a Swiss distributor). In addition, all distributors involved in the distribution of the CIS to qualified investors in Switzerland must enter into a written, Swiss law-governed distribution agreement with the Swiss representative, subject to the conditions set out in the SFAMA Guidelines on distribution of CISs and its template distribution agreement. SFAMA Guidelines on distribution and transparency On 22 May 2014, the SFAMA issued its revised Guidelines on the distribution of CISs (Distribution Guidelines), as well as its revised Guidelines on the charging and use of fees and costs (Transparency Guidelines), which specify certain requirements regarding the distribution of CISs and investors information. These Guidelines entered into force on 1 July 2014 and were recognised as a minimum standard by FINMA. As such, they are of general application for all Swiss and non-swiss market participants. The SFAMA 459

Switzerland provided for various transitional periods, until 31 August 2015 at the latest, to allow financial intermediaries to comply with the new requirements. The Distribution Guidelines apply, inter alia, to fund promoters and fund managers. They include mandatory provisions for distributors that are to be incorporated into the distribution agreements concluded between foreign distributors and the Swiss representative of the non-swiss CIS. In addition, the Guidelines provide for due diligence and information duties both for promoters and distributors of CISs. These include, in relation to distribution to non-qualified investors, the obligation to provide them with objective information on the investment character, opportunities and risks associated with the CIS, by taking into account their experience and knowledge and the complexity of the CIS. The Transparency Guidelines, which apply to distributors and Swiss representatives of non-swiss CISs, impose on them duties of information on fees, costs, rebates and retrocessions. In a nutshell, rebates (i.e., any payment by fund managers, SICAVs or their agents directly made to investors that result in a reduction of the fee or cost attributable to the CIS) are allowed to the extent they are based upon objective criteria (e.g., the subscription amount). The criteria and conditions upon which they are granted must be disclosed in the fund documentation in order to enable the investors to verify whether they are entitled to benefit from such rebates. In the same vein, retrocessions paid to distributors and advisers are allowed but are subject to disclosure requirements (see also Section II.i, supra). They are to be disclosed in the fund documentation and must specify for which services they are paid. In addition, the recipient of the retrocessions is subject to a certain number of specific disclosure duties. He or she must spontaneously inform the investor on the amount of the compensation that he or she receives for distribution by giving the calculation parameters or the spread of these inducements. Upon the investor s request, the recipient is to further disclose the amount actually received. Finally, the recipient is to indicate the existence and nature of any conflicts of interest that are or may be triggered by the payment of retrocessions. In order to incorporate the new disclosure requirements, in March 2015, the SFAMA amended its template notice to Swiss investors to be included in the documentation of foreign CIS guidelines. III COLLECTIVE INVESTMENT SCHEMES From a Swiss legal perspective, asset management services can be rendered either on the basis of a power of attorney that the client grants to the asset manager in relation to assets deposited with a bank (managed account) or through an investment, by the client, in interests or shares of a collective investment scheme. The CISA provides for four different types of collective investment schemes for Swiss CISs: a the contractual investment fund; b the SICAV; c the Swiss investment company (SICAF); and d the Swiss limited partnership (Swiss LP). 460

Switzerland The main characteristics of these legal institutions are set out below. One common requirement is for the Swiss CIS to have substance in Switzerland. i The contractual investment fund The Swiss contractual investment fund is a contractual pool of assets constituted for purposes of common investment, which is separately administered by a licensed fund administration company. The fund administration company, acting on behalf of the investors, deposits the assets of the investment fund with a custodian bank. This legal institution is the most commonly used structure in the Swiss asset management industry. ii The SICAV The Swiss SICAV is a special corporate vehicle governed by the CISA and subject to the supervision of FINMA. The Swiss SICAV s corporate purpose is limited to the collective management of its own assets. Unlike a licensed fund administration company, a SICAV may not perform other activities or services, even ancillary ones such as the management of third-party assets. The Swiss SICAV is in many respects based on the model of the Luxembourg SICAV. The CISA distinguishes between self-managed and externally managed SICAVs. The relevant criterion under the CISA is to determine whether the SICAV performs its own administration, or whether such administration is delegated to a licensed fund administration company. The Swiss SICAV has two types of shares: investor shares and promoter shares. The SICAV is thus composed of at least two segregated sub-funds, one corresponding to the contributions of the investors and one corresponding to those of the promoter. Both types of shares have, as a rule, the same rights and obligations: votes are based on the principle of one share, one vote for both types of shares, there are no restrictions for a holder of one category of shares to hold also shares of the other category, and the creation of preference shares is expressly prohibited. There are important exceptions to the principle of equal treatment among the shareholders. On one hand, the obligation to provide for the minimum capital contribution, as well as the duty to maintain the required capital adequacy requirements for self-managed SICAVs, rest only upon the holders of promoter shares. On the other hand, the holders of promoter shares have the exclusive competence to resolve on the dissolution of the SICAV, to close a sub-fund and to request FINMA to liquidate the SICAV for cause. Following the recent revision of the AMLA framework (see Section II.i., supra), since 1 July 2015, SICAVs are required to keep a register of the ultimate beneficial owners (i.e., individuals owing more than 25 per cent of the company s shares or voting rights) of its unlisted promoter shares. In parallel, holders of those shares are now subject to a reporting obligation towards the SICAV. They are to disclose the name and the address of the ultimate beneficial owners in the event that their participation reaches or exceeds 25 per cent. Breach of this reporting requirement may trigger restrictions or the cancellation of the economic and voting rights related to the investment. According to the applicable transitional provisions, existing holders of unlisted promoter shares must comply with this new requirement by 1 January 2016. These amendments form part of the corporate law reform triggered by the implementation of the FATF recommendations. 461

iii The SICAF Switzerland The SICAF is a Swiss company limited by shares whose corporate purpose is limited to the management of its own assets. The SICAF is not allowed to pursue any entrepreneurial activity. The SICAF is a closed-ended investment scheme, meaning that the investors do not benefit from a redemption (i.e., exit) right. The regulatory framework set forth in the CISA as regards the SICAF is rather limited. The SICAF is substantially governed by the provisions of the Swiss Code of Obligations that are applicable to regular companies limited by shares (including the new disclosure requirements as regards holders of bearer shares and ultimate beneficial owners deriving from the recent revision of the AML framework (see Sections II.i and III.ii, supra)). In this context, a SICAF is not subject to the CISA if its shares are listed on a stock exchange or if its shareholders are exclusively qualified investors (see Section II.v, supra) and its shares are registered shares (as opposed to bearer shares). To our knowledge, all Swiss SICAFs have so far relied on this regulatory safe harbour. As a result, there is currently no Swiss SICAF that is regulated by FINMA. iv The Swiss LP The Swiss LP is a CIS that is aimed at private equity, alternative investments and real estate projects, and that has been designed to mirror the legal form of certain offshore limited partnership structures. The Swiss LP is subject to the supervision of FINMA. Swiss LPs are closed-ended investment schemes, meaning that the investors do not benefit from a redemption (i.e., exit) right. Swiss LPs are managed by one or more general partners (GPs) with unlimited liability for the commitments of a Swiss LP. The GP may delegate certain tasks to third parties to the extent such delegation is in the best interest of the Swiss LP. The asset management function may, however, only be delegated to a regulated asset manager of a Swiss CIS. The investors in a Swiss LP are the limited partners. They may not be involved in the management of the Swiss LP, which is the exclusive competence of the GP. That said, the limited partners benefit from information rights and certain governance rights, such as the delivery of periodic financial information, as well as information on the financial accounts. The Swiss LP is only open to qualified investors (see Section II.v, supra). The partnership agreement of the Swiss LP sets out the key rules that apply among the GP and the limited partners. Swiss law allows a significant freedom to the parties in the regulation of their relationship in the partnership agreement, subject to a limited set of contractual provisions that are required as a matter of law. IV MAIN SOURCES OF INVESTMENT The Swiss asset management industry is heavily reliant upon the assets deposited with Swiss banking institutions. According to figures published by the Swiss Bankers Association in its 2014 Banking Barometer Report, the aggregate amount of assets under management held by Swiss banks amounted to over 6,300 billion Swiss francs at the end of May 2014. This total is divided equally between assets held by Swiss-based and non-swiss based clients. According to the Swiss Funds and Asset Management Association, the Swiss CIS market was valued at 874 billion Swiss francs in June 2015. 462

Switzerland V KEY TRENDS i New regulatory regime for independent asset managers The protection of investment advisory and asset managers clients has been at the top of the Swiss regulator s agenda for several years now, and will be one of the most important legislative projects in the financial services sector for years to come. To ensure better protection of investors, Swiss authorities have recently launched a revision of the regulatory framework applicable to the provision of financial services. From June to October 2014, the Federal Council opened up a consultation procedure on two new instruments: the FinSA and the Financial Institutions Act (FinIA). The FinSA deals with the relationship between the financial intermediary and investors, and essentially provides for rules of conduct aiming at protecting investors upon the provision of financial services or financial instruments in Switzerland. Those proposed rules are primarily based on the EU s MiFID regulations. By contrast, the FinIA includes provisions concerning the relationship between the financial intermediary and the regulatory authority, and imposes licensing and organisational requirements. The provisions as regards asset managers that are already subject to regulatory supervision (namely, qualified asset managers) will be, in principle, incorporated into the FinIA without material change. It should, however, be noted that the draft FinIA provides that pension fund asset managers will be subject to direct FINMA supervision, while retirement benefit institutions (i.e., pension funds) will remain subject to the Swiss Supervisory Commission for Pension Funds. By contrast, independent asset managers who are currently not subject to prudential supervision will be newly supervised. The draft FinIA provides for two options: supervision will be conducted either by FINMA directly or by a semi-state supervisory organisation (whose regulatory activity will in turn be subject to FINMA s oversight). The choice between these two options was one of the issues of the consultation procedure. To date, the Swiss Federal Council has not determined which approach to follow. It should be noted that the draft FinIA also provides for specific provisions for existing asset managers that will benefit from grandfathering provisions. On the specific topic of retrocessions, which was heavily debated during the consultation procedure, on 13 March 2015, the Federal Council confirmed in a decision in principle to allow retrocessions subject to complying with the current transparency regime. The principles laid down in the Swiss case law and FINMA Circular 01/2009 (see Section II.i, supra) should also be crystallised in the FinSA. Following the consultation procedure, revised drafts are to be prepared by the end of 2015. The date of entry into force of the new rules is not expected before 1 January 2017. It is, however, certain that this reform will represent a tidal change for the independent asset management industry. ii Enhanced due diligence requirements in relation to foreign customers assets Since 2012, the Swiss Federal Council has been keen to implement its clean money strategy through, inter alia, the introduction of enhanced due diligence requirements applicable to financial intermediaries. To achieve its objective of a financial centre compliant with tax regulations, financial intermediaries must ensure that foreign clients 463


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Page 1: Asset Management Literature Review and Potential Applications of

Technical Report Documentation Page

1. Report No. FHWA/TX-07/0-5534-1

2. Government Accession No.

3. Recipient's Catalog No. 5. Report Date September 2006 Published: April 2007


6. Performing Organization Code

7. Author(s) Paul E. Krugler, Carlos M. Chang-Albitres, Kirby W. Pickett, Roger E. Smith, Illya V. Hicks, Richard M. Feldman, Sergiy Butenko, Dong Hun Kang, and Seth D. Guikema

8. Performing Organization Report No. Report 0-5534-1

10. Work Unit No. (TRAIS)

9. Performing Organization Name and Address Texas Transportation Institute The Texas A&M University System College Station, Texas 77843-3135

11. Contract or Grant No. Project 0-5534 13. Type of Report and Period Covered Technical Report: September 2005 - August 2006

12. Sponsoring Agency Name and Address Texas Department of Transportation Research and Technology Implementation Office P.O. Box 5080 Austin, Texas 78763-5080

14. Sponsoring Agency Code

15. Supplementary Notes Project performed in cooperation with the Texas Department of Transportation and the Federal Highway Administration. Project Title: Asset Management—Texas Style URL: 16. Abstract This report documents the work performed during phase one of Project 0-5534, “Asset Management—Texas Style.” The overall purpose of the research is to develop state-of-the-practice asset management methodologies for the Texas Department of Transportation (TxDOT). These methodologies will support current decision-making processes for allocating funds to the different asset categories managed by TxDOT. During the first year of this project, the specific research focus area was resource allocation decisions regarding advance acquisition of right-of-way and the construction of new highway capacity facilities. Simulation, optimization, and decision analysis methodologies were explored for examining the trade-offs between using funds for these two alternative purposes. 17. Key Words Asset Management, Simulation, Optimization, Decision Analysis, Right-of-Way, Transportation Planning and Programming

18. Distribution Statement No restrictions. This document is available to the public through NTIS: National Technical Information Service Springfield, Virginia 22161

19. Security Classif.(of this report) Unclassified

20. Security Classif.(of this page) Unclassified

21. No. of Pages 126

Form DOT F 1700.7 (8-72) Reproduction of completed page authorized

Page 2: Asset Management Literature Review and Potential Applications of



Paul E. Krugler

Research Engineer Texas Transportation Institute

Carlos M. Chang-Albitres Associate Transportation Researcher

Texas Transportation Institute

Kirby W. Pickett Consultant

Roger E. Smith

Professor Department of Civil Engineering

Texas A&M University

Illya V. Hicks Assistant Professor

Department of Industrial and Systems Engineering

Richard M. Feldman Professor

Sergiy Butenko Assistant Professor

Dong Hun Kang Research Assistant

Seth D. Guikema Assistant Professor

Department of Civil Engineering Texas A&M University

Report 0-5534-1 Project 0-5534

Project Title: Asset Management—Texas Style

Performed in cooperation with the Texas Department of Transportation

and the Federal Highway Administration

September 2006 Published: April 2007

TEXAS TRANSPORTATION INSTITUTE The Texas A&M University System College Station, Texas 77843-3135

Page 4: Asset Management Literature Review and Potential Applications of

The contents of this report reflect the views of the authors, who are responsible for the

facts and the accuracy of the data presented herein. The contents do not necessarily reflect the

official view or policies of the Federal Highway Administration (FHWA) or the Texas

Department of Transportation (TxDOT). This report does not constitute a standard,

specification, or regulation. The engineer in charge was Paul E. Krugler, P.E. (Texas #43317).

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This project is being conducted in cooperation with TxDOT and FHWA. The authors

wish to acknowledge the strong support of the project director, Ron Hagquist; the program

coordinator, Mary Owen; and the entire group of project advisors. Special thanks are extended

to John D. “JD” Ewald and Patrick Moon of the Right of Way Division, Wayne Wells of the

Transportation Planning and Programming Division, and Linda K. Olson of the Design Division

who met at length with the research team during the past year to convey current TxDOT

processes and methods pertinent to this project.

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Page List of Figures .............................................................................................................................. viii List of Tables ................................................................................................................................. ix Chapter 1: Introduction .................................................................................................................. 1

Organization of the Report.......................................................................................................... 2 Chapter 2: Asset Management Literature Review.......................................................................... 5

Asset Management Concepts ..................................................................................................... 5 Top Asset Management References.......................................................................................... 14

Chapter 3: Conceptual Schematic Research Problem Overview.................................................. 23 Funding Allocation and Decision Making at TxDOT .............................................................. 23 Allocating Funds between Maintenance and New Road Capacity Construction ..................... 25 TPP and ROW from an Asset Management Perspective.......................................................... 29 Overview of the Right-of-Way Acquisition Process ................................................................ 31 Right-of-Way Acquisition, Early Purchase, and Cost Impacts................................................. 36

Chapter 4: Simulation ................................................................................................................... 41 Abstract ..................................................................................................................................... 41 Introduction............................................................................................................................... 41 Trade-Offs for Early Acquisition.............................................................................................. 46 A Summary of Simulation Modeling........................................................................................ 47 The Importance of Stochastic Modeling................................................................................... 49 Objectives for the Simulation Model........................................................................................ 50 Research Plan............................................................................................................................ 52 Modeling Approach .................................................................................................................. 55 Concluding Remarks................................................................................................................. 59

Chapter 5: Optimization................................................................................................................ 61 Abstract ..................................................................................................................................... 61 Introduction............................................................................................................................... 61 Data Collection and Processing ................................................................................................ 69 Mathematical Programming Models......................................................................................... 72 Expected Outputs and Extensions............................................................................................. 76

Chapter 6: Decision and Risk Analysis ........................................................................................ 79 Abstract ..................................................................................................................................... 79 Introduction............................................................................................................................... 79 Introduction to Decision Analysis ............................................................................................ 82 Past Uses of Decision Analysis................................................................................................. 90 Preliminary Objective Hierarchy .............................................................................................. 91 Identifying Promising Candidate Parcels for Early Acquisition Options................................. 94 Next Steps in the Development Process: Requirements and Limitations................................. 98 Implementing a Combined Right-Of-Way/Asset Management Method within the TxDOT Organizational Setting .............................................................................................................. 99 Concluding Remarks............................................................................................................... 101

Chapter 7: Conclusions and Recommendations ......................................................................... 103 References ................................................................................................................................. 107

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Page Figure 2-1. Resource Allocation and Utilization Process in Asset Management

(AASHTO 2002). ......................................................................................................... 6 Figure 2-2. Example Types of Physical Assets (TTI 1995)............................................................ 7 Figure 2-3. Example Types of Activities (TTI 1995). .................................................................... 7 Figure 2-4. Example Types of Resources (TTI 1995). ................................................................... 8 Figure 2-5. Components of an Asset Management System (Smith 2005).................................... 10 Figure 3-1. Funding Allocation to Maintenance and New Road Capacity (Hagquist 2006)........ 26 Figure 3-2. Funding Allocation to New Road Capacity and Right-of-Way (Hagquist 2006)...... 27 Figure 3-3. The Cost of Delaying Right-of-Way Advance Purchase (after Hagquist 2006)........ 27 Figure 3-4. Opportunity Cost of Not Accelerating Construction Projects (after

Hagquist 2006). .......................................................................................................... 28 Figure 3-5. Optimal Strategy for Minimizing Cost over a Planning Horizon (after

Hagquist 2006). .......................................................................................................... 28 Figure 3-6. Right-of-Way Acquisition and the Project Development Process. ............................ 36 Figure 3-7. Schematic Diagram of Right-of-Way Parcel Acquisition.......................................... 37 Figure 3-8. Right-of-Way Acquisition Cost versus Time............................................................. 38 Figure 3-9. Risk versus Time during Right-of-Way Acquisition Process. ................................... 38 Figure 4-1. Comparison of Deterministic and Stochastic Project Scheduling.............................. 49 Figure 4-2. Schematic Diagram of Simulation-Based Decision-Support System. ....................... 51 Figure 4-3. Illustration of an Event and Activity Diagram........................................................... 57 Figure 5-1. Average Assessed Land Values (in Dollars per Acre) in the Study by Siethoff

(2000) ......................................................................................................................... 71 Figure 6-1. Overview of the Decision Analytic Asset Management Model from Guikema

and Milke (1999). ....................................................................................................... 83 Figure 6-2. Simple Example Objective Hierarchy........................................................................ 84 Figure 6-3. Example Decision Tree for a Fictitious Right-of-Way Option on a Single

Parcel. ......................................................................................................................... 89 Figure 6-4. Preliminary Objective Hierarchy for TxDOT Transportation Asset Management.... 93 Figure 6-5. Preliminary Approach for Integrating a Combined Asset Management/

Right-of-Way Model into the TxDOT Planning Framework................................... 100

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Table 2-1. Top Literature References in Transportation Asset Management............................... 15 Table 2-2. Literature in Asset Management Practices at U.S. State Departments of

Transportation ............................................................................................................. 18 Table 2-3. Literature in Right-of-Way Asset Management .......................................................... 20 Table 3-1. Funding at a Glance (TxDOT 2003a).......................................................................... 24 Table 3-2. TPP and ROW in Asset Management ......................................................................... 30 Table 4-1. Selected Literature in Simulation ................................................................................ 44 Table 5-1. Selected Literature in Optimization............................................................................. 67 Table 6-1. Example Constructed Scale for the Objective “Maximize Construction Quality” ..... 84

Page 10: Asset Management Literature Review and Potential Applications of

Project 0-5534 September 2006 Report 0-5534-1


This report documents the work performed during phase one of Project 0-5534, “Asset

Management—Texas Style.” The overall purpose of the research is to develop state-of-the-

practice asset management methodologies for the Texas Department of Transportation (TxDOT).

These methodologies will support current decision-making processes for allocating funds to the

different asset categories managed by TxDOT. In the long-term, it is envisioned that the benefits

of developing and implementing an enhanced TxDOT asset management framework and practices

will be reflected in lower long-term costs and improved performance of TxDOT-managed

transportation facilities. It is also a goal for the state-of-the-practice asset management

methodologies to be developed to provide better means of communicating TxDOT’s funding

needs to the Texas Transportation Commission and Texas Legislature.

A comprehensive literature review on asset management practices was conducted at the

outset of this project. Also, key administrators and managers within TxDOT were interviewed to

gather additional valuable information. This information allowed the research team to gain a

more complete understanding of TxDOT’s goals and needs and thereby to become better

positioned to meet the research project objectives.

From these interviews our research team discovered that TxDOT upper management was

interested in focusing initial project efforts on selected asset management decisions made in the

Right of Way Division (ROW) and the Transportation Planning and Programming Division (TPP).

Hence, during the first year of this project, the specific focus area of the research was resource

allocation decisions regarding advance acquisition of right-of-way and the construction of new

highway capacity facilities. Simulation, optimization, and decision analysis methodologies were

explored for examining the trade-offs between using funds for these two alternative purposes.

Three small work groups were formed to explore these potential applications for business

methodologies. Credit needs to be given to the individual efforts of these research work groups.

Dr. Richard Feldman and Dr. Dong Hun Kang formed the simulation research group, Dr. Illya

Hicks and Dr. Sergiy Butenko formed the optimization research group, and Dr. Seth Guikema

provided the decision analysis study.

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Working simultaneously and somewhat independently, each group has proposed herein

an approach to provide an asset management solution for TxDOT in the phase one focus area.

The work of each group was overseen by research team management, but each work area was

free to develop potential solutions from their own perspective and area of expertise.

This somewhat unique work methodology is reflected in this report, as each of the three

approaches is presented in a separate chapter. Each approach presents a unique perspective and

should be read and considered independently. The primary advantage of this research approach is

that an expanded number of potential alternatives are provided for addressing the research

problem. At the end of the report, a summary of each potential approach is presented. Some

common activities are identified as the next steps envisioned for this project.


This report includes the results of the asset management literature review, a conceptual

schematic overview of the specific problem and ideas to solve it, and detailed descriptions of

potential applications of simulation, optimization, and decision analysis techniques for use by

TxDOT in asset management decision-making processes.

The report is composed of seven chapters. This chapter provides an introduction of the

overall research. It describes project objectives and the nature of the research problem. It also

describes the work methodology followed during phase one of the research and describes the

organization of this report.

Chapter 2 presents a literature review of asset management concepts, asset management

practices in other states, and research efforts focused on right-of-way topics pertinent to early

right-of-way acquisition. The most beneficial information items in each of these three areas are

highlighted in this chapter.

Chapter 3 introduces the conceptual schematic overview that was used as an overall

vision upon which the proposed simulation, optimization, and decision analysis approaches were

Chapter 4 describes a simulation approach that can be used to assist TxDOT in making

early right-of-way acquisition decisions. An event-driven simulation technique is proposed.

Specific objectives of the early acquisition simulation tool and a list of the various project phases

and tasks needed for completing the development of the simulation approach are presented. The

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output of the proposed simulation model will be a projection of expected annual expenses

associated with the project plus best- and worst-case scenarios representing likely variations in

expenses due to random events.

Chapter 5 discusses optimization-based approaches to investigating resource allocation

options, particularly those related to right-of-way acquisition. A brief introduction to the area of

optimization and its major research directions and developments is provided. The chapter then

describes the data collection and processing procedures, at both district and division levels,

required for successful completion of this project using optimization approaches. Two

alternative optimization approaches for optimal resource allocation are proposed: the top-to-

bottom and the bottom-to-top approaches. The top-to-bottom approach uses two different types

of models. The first model is used to evaluate relative budget needs for early right-of-way

acquisition among districts. It supports decision making done by division personnel and agency

administrators. The second model will assist each district as the districts determine which

projects offer the best use of their allocated budgets for early right-of-way acquisition. On the

other hand, the bottom-to-top approach first applies the detail-involved model at the specific

project and district level, and then uses the results of this analysis to assist allocating the budget

for early right-of-way acquisition among districts.

Chapter 6 summarizes the usefulness of decision and risk analysis techniques for

transportation asset management. Decision analysis can be summarized as an approach for

supporting decisions when input is complex. The development of a hierarchy and utility

function as a methodology to assist in the decision-making process is proposed. The approach

proposed for decision analysis relies primarily on subjective knowledge captured from current

decision makers and practitioners.

Chapter 7 presents the conclusions and recommendations resulting from phase one

research tasks. It also includes a list of activities suggested as the next steps for the second phase

of this project. A list of references cited in this report follows.

Products 0-5534-P1 and 0-5534-P2 are included in this report. Product 0-5534-P1,

“Literature Review,” is Chapter 2, and Product 0-5534-P2, “Potential Optimization, Simulation,

and Decision Analysis Asset Management Applications in Phase One Focus Area,” is composed

of Chapters 4, 5, and 6.

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The literature review included asset management concepts, current asset management

practices and philosophies of other state departments of transportation (DOTs) and the FHWA,

and research efforts focused on right-of-way acquisition. The purpose of this review was to

ensure that TxDOT and the research team will benefit from state-of-the-art concepts and

practices for asset management.


Asset management is an emerging effort to integrate finance, planning, engineering,

personnel, and information management to assist agencies in managing assets cost-effectively

(AASHTO 1997). In its broadest sense, asset management is defined as “a systematic process of

maintaining, upgrading, and operating assets, combining engineering principles with sound

business practice and economic rationale, and providing tools to facilitate a more organized and

flexible approach to making the decisions necessary to achieve the public’s expectations”

(OECD 2001). The main objective of asset management is to improve decision-making

processes for allocating funds among an agency’s assets so that the best return on investment is

obtained. To achieve this objective, asset management embraces all of the processes, tools, and

data required to manage assets effectively (Nemmers 2004). For this reason asset management is

also defined as “a process of resource allocation and utilization” (AASHTO 2002).

The framework needed to carry out this process effectively encompasses an agency’s

policy goals and objectives, performance measurements, planning and programming, program

delivery, and system monitoring and performance results, as shown in Figure 2-1.

1 The contents of this section have been partially extracted with consent of the author from the unpublished dissertation “Development of a Multi-Objective Strategic Management Approach Oriented to Improve Decisions for Pavement Management Practices in Local Agencies” by Carlos M. Chang-Albitres.

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Figure 2-1. Resource Allocation and Utilization Process in Asset Management

(AASHTO 2002).

Asset management decisions are based on policy goals and objectives. The agency

establishes policy goals and objectives to reflect the desired system condition and target level of

service. Performance measures are selected to express the desired system condition and target

level of service in an objective manner, and to allow tracking of progress toward desired goals.

Planning and programming are complex processes since the agency manages several

types of physical infrastructure facilities, including those illustrated in Figure 2-2. A structured

asset management system should provide information about the effects of investing different

levels of funding in each of these various types of facilities and the effects of investing more in

one type while investing less in another.

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Figure 2-2. Example Types of Physical Assets (TTI 1995).

The agency also decides how to allocate available resources among various types of

activities involved with each type of physical asset. Example activities are illustrated in

Figure 2-3.

Figure 2-3. Example Types of Activities (TTI 1995).

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A structured asset management system must provide information about both the short-

term and long-term impacts of allocating different amounts of resources among those activities.

Additionally, an agency manages many different types of resources, such as those shown in

Figure 2-4, and the structured asset management system should show the impact of limitations

on the different amounts of the various types of resources. These impacts should be expressed in

terms of performance measures.

Figure 2-4. Example Types of Resources (TTI 1995).

Programs developed during the planning stage are delivered and periodically evaluated

by the agency. Results from program delivery are monitored using performance measures to

quantify the asset management program’s effectiveness and to allow timely corrective actions as

Components of an Asset Management System

An asset management system undertakes several procedures, enhancing different

components, tools, and activities. Asset management systems provide decision makers with

tools for evaluating probable effects of alternative decisions. These tools develop decision-

support information from quantitative data regarding the agency’s resources, current condition of

physical assets, and estimations of their current value.

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According to the Federal Highway Administration (FHWA), to effectively support the

asset management process, an asset management system should include (FHWA 1999):

• strategic goals;

• inventory of assets;

• valuation of assets;

• quantitative condition and performance measures;

• measures of how well strategic goals are being met;

• usage information;

• performance-prediction capabilities;

• relational databases to integrate individual management systems;

• consideration of qualitative issues;

• links to the budget process;

• engineering and economic analysis tools;

• useful outputs, effectively presented; and

• continuous feedback procedures.

These asset management elements can be grouped into five major building blocks: basic

information, performance measures, needs analysis, program analysis, and program delivery.

Figure 2-5 shows in detail the individual components of each building block, providing a

comprehensive view of an asset management system.

Goals, objectives, and policies as well as inventory data are considered in the basic

information block. Condition assessment and desired levels of service are components of the

performance measures block. Performance modeling and prediction along with action and

funding analysis constitute the needs analysis block. Alternative analysis and program

optimization are in the program analysis block. Program development and program

implementation belong to the program delivery block. Finally, performance monitoring and

feedback complete the cycle of the asset management process.

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Figure 2-5. Components of an Asset Management System (Smith 2005).

Basic Starting Information

Goals, Objectives &

Inventory Data

Performance Measures

Condition Assessment

Desired Levels of Service

Needs Analysis

PerformanceModeling & Prediction

Action & Funding Analysis

Program Analysis

Alternative Analysis

Program Optimization

Program Delivery

Program Development

Program Implementation

Available Funds

Performance Monitoring

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Goals, Objectives, and Policies

Asset management is a goal-driven management process. To manage assets effectively,

the decision-making process must be aligned with the agency’s goals, objectives, and policies.

Goals are expressed in terms of objectives to be met over the planning horizon. Policies are

developed to provide the necessary framework to support achieving target objectives. Policies

regarding engineering standards, economic development, community interaction, political issues,

administration rules, and the agency’s organizational structure influence asset management


Data Inventory

The asset inventory contains information about physical location, characteristics, usage,

work history, work planned, costs, resources, and any other information considered relevant by

the agency. Additional information provided by asset management systems may include financial

reports about the agency’s assets, showing both the current economic value and future asset

value estimates. Decisions regarding the type and amount of data to be collected are made based

on the agency’s needs for decision support and available resources.

Knowledge of current condition is needed to assess the asset network current scenario.

Condition assessment is expressed in terms of performance measures selected by the agency.

These performance measures should be the ones used by the agency to establish objectives.

Condition indices, percentage of the network system rated in good condition, and remaining life

of the asset network are some examples of performance measures used for physical assets.

Desired Level of Service

Performance measures are also used to establish the desired level of service for the asset

network. Establishing level of service goals for the planning horizon allows the development of

strategies to achieve those goals.

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Performance Modeling

Performance models are used to predict future scenarios for the asset network. Projecting

the asset network condition over the planning horizon serves to identify future funding needs.

Appropriate selection of performance models is essential to effective asset management. The

selection of performance models is based on the types of assets being managed and the data

available in the agency’s data inventory to support the models.

Action and Funding Analysis

Actions considered in the strategy require funding. Funding analysis involves forecasting

the impact of investment strategies on the asset network. This impact is assessed by analyzing

changes in performance measures used by the agency.

Alternative Analysis Methodologies

Program analysis implies studying different alternatives that may be feasible for

implementation. Analytical tools are developed to assist agencies in evaluating the implications

of different investment scenarios and work plan strategies. “What if” analyses are usually

performed to assess the impact of alternative management decisions. This type of analysis is

difficult, if not impossible, without the assistance of analytical tools. Analytical tools to assist

evaluating alternative decisions may involve simulation, life-cycle costing, benefit/cost analysis,

database query, optimization, risk analysis, and other methodologies. Decision-support tools to

assist an agency’s personnel in identifying needs and comparing investment alternatives are

essential in the asset management process.

The available budget is allocated among a subset of projects requiring funds. Decisions

are made about how to allocate limited funds to new construction, rehabilitation, maintenance,

and rehabilitation projects. The aim is to optimize the use of funds invested by selecting the best

overall group of projects from among all of these funding categories.

Project-selection criteria should be established to assist in the selection of the best group

of projects. Having criteria for project selection implies having methods of identifying both

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short- and long-term effects expected from projects. Methods of prioritizing work activities and

selecting projects are based on economic techniques, but social and political factors should also

be considered in the criteria.

The implementation program must address every aspect of the management process.

Procedures for goal review, policy review, data collection, data storage, data access, condition

assessment, budget development, construction, maintenance, monitoring, and feedback should be

considered in the implementation program. The implementation program should involve all

management levels that participate in the decision-making process. The implementation of an

asset management approach in the programming and budgeting cycle requires continuous

encouragement from upper management as well as commitment from all personnel involved. In

practice, an asset management approach can only succeed if it can support the agency

management process efficiently. The effectiveness of an asset management approach should be

reflected in savings to the agency. However, these benefits can only be achieved if the agency

ensures that the asset management system is properly used at all management levels.

Monitoring the asset performance over the planning horizon serves to assess whether the

desired level of service is being accomplished or not. Performance monitoring requires tracking

performance over time, which allows the agency to detect changes in the asset condition and to

take necessary corrective actions if needed. The desired level of service targeted by the agency

may also be adjusted based on results from implementation.

Feedback is an essential activity to maximize the agency’s benefits from an asset

management system. The asset management system should be capable of incorporating lessons

learned from monitoring the ongoing process. Goals, objectives, and the agency’s policies may

be adjusted based on feedback from implementation. However, great care should be taken before

modifying core components of the system. Frequent modifications can damage its credibility.

Major modifications to the system, including changes in database requirements, prediction

models, economic analysis techniques, and reporting tools, deserve careful evaluation. Minor

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changes that simplify the flow of information in the process are preferred. Particularly preferred

are those changes that provide better means of accomplishing the agency’s objectives without

disturbing ongoing activities.


Top asset management references were identified during the literature review. Selected

top reference items are presented in Table 2-1. In our judgment the items listed in Table 2-1

reflect the current state-of-the-art in asset management. Core principles, concepts, applications,

tools, and practices presented in this selection set the framework for the development and

implementation of asset management.

Table 2-2 lists reference items that present the asset management experience in several

states in the United States. The document on top of the list describes the funding allocation and

project-selection process followed by the Texas Department of Transportation. Specific

experiences in asset management practices conducted in New York, Michigan, Pennsylvania,

Virginia, and Colorado in coordination with the Federal Highway Administration Office of Asset

Management are summarized.

Few research efforts were found that focused on the application of asset management

principles in the right-of-way field. The items found in this area are shown in Table 2-3. TxDOT

right-of-way manuals and previous research conducted for TxDOT were considered the primary

references. In addition to these items, a research report published in 2005 by the Minnesota

Department of Transportation addresses the question of whether there are financial benefits to

acquiring transportation right-of-way far in advance of when the improvement will be done.

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Table 2-1. Top Literature References in Transportation Asset Management. Item

Number Name Author Year Brief Summary*

1-001 AASHTO Transportation

Asset Management Guide Cambridge Systematics, Inc.

2002 This American Association of State Highway and Transportation Officials (AASHTO) guide provides state departments of transportation (DOTs) and other transportation agencies guidance on implementing asset management concepts and principles within their business processes. At its core, asset management deals with an agency’s decisions in resource allocation and utilization in managing its system of transportation infrastructure.

1-002 FHWA Asset Management Primer

U.S. Department of Transportation

1999 This document explains the basics of asset management: What is asset management? Why do we need asset management? An overview of current practices in asset management and a vision into the future for improving the process are presented.

1-003 FHWA “Asset Management Position Paper: White Paper”

Cambridge Systematics, Inc.

2004 This document describes asset management concepts and core principles. White papers for each major area in the asset management program are presented, including infrastructure, planning, operations, safety, environment, right-of-way, and federal lands.

1-004 Analytical Tools for Asset Management

2006 This report presents new analytical tools to support asset management. Emphasis is given to tools needed to assist agencies in trade-off decisions for resource allocation.

1-005 Best Practices for Linking Strategic Goals to Resource Allocation and Implementation Decisions Using Elements of a Transportation Asset Management Program

Midwest Regional University Transportation Center

2004 This report assembles a set of tools, based on the experiences and best practices in a diverse set of states, for linking strategic goals to resource allocation. Based on detailed documentation of the practices in five states—Florida, Maryland, Michigan, Montana, and Pennsylvania—a synthesis of best practice of strategic planning, asset management, and the linkage between the two was developed.

* Descriptions are from the documents.

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Table 2-1. Top Literature References in Transportation Asset Management (Continued). Item

1-006 6th National Conference

on Transportation Asset Management

Transportation Research Board

2006 The 6th National Conference on Transportation Asset Management was held November 1-3, 2005, in Kansas City, Missouri. More than 250 attendees benefited from the technical presentations and facilitated discussions conducted at the conference. This circular summarizes the content of the conference’s sessions and presentations.

1-007 “Developing a Road Map for Transportation Asset Management Research”

Aileen Switzer and Sue McNeil

2004 This article synthesizes the initiatives from a number of professional and government organizations to develop a research road map for transportation asset management. This road map is intended to identify research needs and provide significant milestones along the way.

1-008 Performance-Based Planning and Asset Management

Lance A. Neumann and Michael J. Markow

2004 Performance-based planning is systematic and analytic, building upon the following components: expressions of policy in terms of quantifiable objectives; explicit measures of system performance; analytic methods to predict impact of different types of investments; models for system monitoring; and feedback mechanisms to assess performance trends.

1-009 Performance Measures and Targets for Transportation Asset Management

2006 Volume I describes the research effort and provides the current state-of-the-practice on the use of performance measures, principally in the context of transportation asset management. Volume II introduces a framework for identifying performance measures and setting target values, and its appendices contain examples of performance measures and targets.

1-010 “Integrating Pavement and Asset Management in Functional and Operational Terms”

Ralph Haas, Lynne Cowe Falls, and Susan Tighe

2004 If asset management and its component systems are to function in a coordinated and effective way, an integration platform is required. This paper suggests that three key elements need to be included in such a platform. They are locational referencing, asset valuation, and level of service.

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Table 2-1. Top Literature References in Transportation Asset Management (Continued).

Item Number

Name Author Year Brief Summary*

1-011 Transportation Asset Management in Australia, Canada, England, and New Zealand

David Geiger et al.

2005 FHWA, AASHTO, and the National Cooperative Highway Research Program (NCHRP) sponsored a scanning tour to observe asset management experiences, techniques, and processes in the four countries. In this study, the U.S. team observed that asset management as an organizational culture and decision-making process is critical to transportation programs facing significant capital renewal and preservation needs and that successful programs require top-level commitment.

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Table 2-2. Literature in Asset Management Practices at U.S. State Departments of Transportation.

Project Selection Process

Texas Department of Transportation

2003 This document explains the funding allocation and project-selection process followed by the Texas Department of Transportation. Five steps are considered in the project-selection process: identify needs, consider funding, planning, project development, and construction.

2-002 Economics in Asset Management— The New York Experience

FHWA 2003 This case study shows the effort of the New York Department of Transportation (NYDOT) to implement asset management. NYDOT has developed a prototype Transportation Asset Management (TAM) trade-off model that employs economic trade-off analysis to compare the dollar value of customer benefits to investment costs among competing investment candidates. The model ranks the candidate projects by rate of return.

2-003 Data Integration— The Pennsylvania Experience

FHWA 2004 The Pennsylvania Department of Transportation (PENNDOT) is simultaneously implementing top-down and bottom-up approaches to data integration. The central component of this process is a series of projects to update the department’s highway, bridge, and maintenance management practices, and the legacy systems that support them. PENNDOT’s approach to data integration combines strategic business process improvements with information technology (IT) enhancement.

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Table 2-2. Literature in Asset Management Practices at U.S. State Departments of Transportation (Continued).

2-004 Data Integration— The Michigan Experience

FHWA 2003 In 1991, the Intermodal Surface Transportation Efficiency Act (ISTEA) provided the impetus for a comprehensive redesign of the Michigan Department of Transportation’s (MDOT) business practices within an asset management framework, with data management as a key requirement for the decision-making process. To support the decision-making process, MDOT began its data integration effort by building the Transportation Management System (TMS), migrating key planning, programming, and project-delivery data from a mainframe to a user-friendly environment.

2-005 Data Integration— The Virginia Experience

FHWA 2004 The Virginia Department of Transportation (VDOT) initiated the development of infrastructure decision-support systems and a large data collection program, referred to as the Inventory and Condition Assessment System (ICAS). VDOT’s new data integration strategy has enabled it to make significant progress in the development of decision-support tools and the integration of asset management data without waiting for the details of the final asset management system. In 2003, VDOT completed the needs-based budget request module for the asset management system.

2-006 Data Integration— The Colorado Experience

FHWA 2004 Since 2000, the Colorado Department of Transportation (CDOT) has undertaken several important initiatives designed to improve transportation planning, decision making, and resource allocation. CDOT approached the issue of data integration to support asset management from both the policy and information technology perspectives. CDOT established a strong policy framework to support asset management and data integration.

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Table 2-3. Literature in Right-of-Way Asset Management. Item

ROW Manual: Volume 1—ROW Procedures Preliminary to Release

TxDOT 2005 This eight-volume manual is intended to provide guidance in the acquisition of right-of-way for transportation projects. The manual represents the current information and operating practices for acquisition of right-of-way for transportation projects, property management relating to right-of-way, and the highway beautification program. Volume 1 consists of the four chapters: “Project Development Overview,” “Contractual Agreements,” “Acquisition Coordination,” and “Surveying, Maps, and Parcels.”

ROW Manual: Volume 2—Right of Way Acquisition

TxDOT 2006 Volume 2 of the ROW Manual addresses the requirements and the procedures for right-of-way acquisition in detail. Administrative requirements before and after the project releases, types of project releases, and advance acquisition of right-of-way are described in the manual.

3-003 The Financial Benefits of Early Acquisition of Transportation Right of Way

Minnesota Department of Transportation

2005 This report addresses the question of whether there are financial benefits to acquiring transportation right-of-way far in advance of when the improvement will be done. The first part of the analysis is very general, comparing rates of price increase for different types of properties to the opportunity costs of holding land, over a long historical period. The second part of the analysis focuses on Minnesota and examines property price increases by county over shorter, more recent, time periods.

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Table 2-3. Literature in Right-of-Way Asset Management (Continued). Item

3-004 Right-of-Way Costs and

Property Values: Estimating the Costs of Texas Takings and Commercial Property Sales Data

Center for Transportation Research, The University of Texas

2004 Right-of-way cost estimation models are proposed using acquisition data from Texas corridors and separate databases of full-parcel commercial sales transactions for Texas’ largest regions. A budget estimation tool developed in Excel was one of the products of this research.

3-005 The Costs of Right of Way Acquisition: Methods and Models for Estimation

Jared D. Heiner and Kara M. Kockelman

2004 This paper presents a literature review of related right-of-way acquisition and property valuation. It describes the appraisal process and the influence of federal law on acquisition practices. It provides hedonic-price models for estimation of costs associated with taking property using recent acquisition data from several Texas corridors and full-parcel commercial sales transactions in Texas’ largest regions.

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A conceptual schematic overview as an overall vision for addressing the research

problem is presented in this chapter. This overall vision was used as a preliminary framework

upon which the simulation, optimization, and decision analysis approaches were crafted. Most

of the thoughts presented in this chapter were provided by Ron Hagquist, TxDOT project

director for this project. Many other valuable ideas came from interviews with TxDOT

administrators and managers and from documentation in the focus research area. All this

information allowed assembling the conceptual schematic overview. Our research team would

not have been able to develop the simulation, optimization, and decision analysis approaches

presented in the next chapters of this report without direction and close guidance from TxDOT.

TxDOT upper management provided the overall direction for the project. Guidance from

meetings with the Transportation Planning and Programming Division and Right of Way

Division allowed establishing the ultimate goal for this project, which is examining the trade-offs

between using funds for advance purchase of right-of-way and using those funds for accelerating

completion of new or additional-capacity projects.


Texas is currently faced with the need to fund many more transportation projects than the

available funding will cover, a situation for which no end appears to be in sight. So it is essential

that TxDOT maximize the effectiveness of the various funding sources available to them. One

of the prime considerations has been, and remains, to make certain that all federal funding

allocated to Texas is utilized. TxDOT has always been able to accomplish this goal. With the

ever-increasing needs in transportation, it becomes equally important to make the most

advantageous use of other funding sources: state and local funds, along with tolls and bonds.

TxDOT funding categories are presented in the document “Project Selection Process”

(TxDOT 2003a) published by TxDOT. There are 12 funding categories, as shown in Table 3-1.

The project-selection process in each category and sources of funding are summarized in this

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Table 3-1. Funding at a Glance (TxDOT 2003a).

Funding Category Starting Point Project Selection Usual Funding

Preventive Maintenance and


TxDOT District Projects selected by districts.

Federal 90 percent, State 10 percent; or Federal 80 percent, State 20 percent; or State 100 percent

Structures Replacement and

TxDOT District

Commission approves projects statewide on a cost-benefit basis using the Texas Eligible Bridge Selection System (TEBSS).

Federal 80 percent, State 20 percent; or Federal 80 percent, State 10 percent, Local 10 percent; or State 100 percent

Metropolitan Area Corridor Projects

Commission approves projects in corridors. Projects scheduled by consensus of districts.

Federal 80 percent, State 20 percent; or State 100 percent

Urban Area Corridor Projects

Statewide Connectivity

Corridor Projects

Congestion Mitigation and Air

Quality Improvement

Metropolitan Planning

Organization (MPO)

Projects selected by MPOs in consultation with TxDOT and the Texas Commission on Environmental Air Quality and funded by districts. Commission allocates money based on population percentages within areas failing to meet air quality standards.

Federal 80 percent, State 20 percent; or Federal 80 percent, Local 20 percent

Metropolitan Mobility/

Rehabilitation MPO

Projects selected by MPOs in consultation with TxDOT and funded by district’s Allocation Program. Commission allocates money based on population.

Federal 80 percent, State 20 percent; or Federal 80 percent, Local 20 percent; or State 100 percent

Safety Federal Hazard

Elimination Program and Federal Railroad

Safety Signal Program

Projects selected statewide by federally mandated safety indices and prioritized listing. Commission allocates funds to districts.

Federal 90 percent, State 10 percent; or State 100 percent

Transportation Enhancements

Local entities make recommendations, and a TxDOT committee reviews them. Projects selected and approved by commission on a per-project basis.

Miscellaneous State Park Roads, Railroad Grade

Crossings Replanking, Railroad Signal Maintenance,

and Construction Landscaping

TxDOT District, Texas

Parks and Wildlife Dept.,

Other (Federal


Projects selected statewide by Traffic Operations Division or Texas Parks and Wildlife Department. Local projects selected by districts. Commission allocates funds to districts or approves participation in federal programs with allocation formulas.

State 100 percent; or Federal 80 percent, State 20 percent; or Federal 100 percent

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Table 3-1. Funding at a Glance (TxDOT 2003a) (Continued).

District Discretionary TxDOT District

Projects selected by districts. Commission allocates money through Allocation Program.

Federal 80 percent, State 20 percent; or Federal 80 percent, Local 20 percent; or State 100 percent B

Strategic Priority Commission Commission selects these projects on a project-specific basis.

Since funding is limited, from whatever sources, determining best use of the funding

results in “trade-offs” among the different aspects of TxDOT’s objectives. For example, if funds

are used to purchase right-of-way, funds available for construction projects or other areas of

operation would be reduced by that amount, and vice versa. With new legislation allowing

TxDOT to purchase options on future right-of-way purchases, and the possibility of obtaining

legislation that could allow advance right-of-way purchases, it becomes especially important that

the amount of funding utilized for right-of-way be optimized. The benefit of early right-of-way

acquisition is avoidance of escalating costs. Project planning and letting schedule predictability

would also be considerably improved where early acquisition is most appropriate. On the other

hand, the benefits of accelerating project completion are (1) avoiding highway construction cost

increases and (2) earlier delivery of transportation benefits to travelers.



The initial trade-off of allocating funds between maintenance and new road capacity

construction projects is illustrated in Figure 3-1.

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Figure 3-1. Funding Allocation to Maintenance and New Road Capacity (Hagquist 2006).

The specific area of focus of this research is the new road capacity and right-of-way as

shown in Figure 3-2. Specifically, the challenge is to find if there is an optimal strategy for

advance purchase of right-of-way, with the aim that this strategy would minimize the combined

costs of right-of-way purchase and delay of new or additional capacity projects. The potential

cost impact of delaying right-of-way advance purchase is shown in Figure 3-3. The opportunity

cost of not accelerating construction projects is illustrated in Figure 3-4.




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Figure 3-2 Funding Allocation to New Road Capacity and Right-of-Way (Hagquist 2006).

Figure 3-3. The Cost of Delaying Right-of-Way Advance Purchase (after Hagquist 2006).



Purchase Price Increase over Time

$ to Advance Purchase

Maximum cost

Minimum cost

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Figure 3-4. Opportunity Cost of Not Accelerating Construction Projects

(after Hagquist 2006).

It may be feasible that by combining these two situations for a fixed budget, an optimal

strategy for minimizing cost over a planning horizon can be found, as illustrated in Figure 3-5.

Figure 3-5. Optimal Strategy for Minimizing Cost over a Planning Horizon

Value to TxDOT And Travelers

$ to Project Acceleration

Maximum value

Sum of right-of-way Inflation and Project Delay Opportunity

0 $ to Project Acceleration

Maximum $ to projects; Minimum project delay; Maximum ROW Maximum $ to advance ROW

100 $ to Advance Right-of-Way

Least total cost strategy

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Challenges in Solving the Funding Allocation Problem

The ideas presented in the previous section of this chapter give us a conceptual schematic

overview of the funding allocation problem between right-of-way acquisition and new

construction capacity. In the real world the problem is more complex and poses a great

challenge. The complexity of the problem is due to different aspects. Some of the aspects to be

considered in formulating a practical approach to address this challenge include:

• the interrelationship between right-of-way and project construction,

• the highly complex sequence of decisions and events in the right-of-way acquisition

process, and

• the possibility of buying and exercising right-of-way purchase options.

This challenge may be approached in several ways using techniques from simulation,

optimization theory, or decision analysis, or some combination of these.

The following sections of this chapter contain a summary of an asset management

perspective for transportation planning and programming and right-of-way; an overview of the

right-of-way acquisition process; and additional thoughts on right-of-way acquisition, early

purchase, and cost impacts. These sections set the framework for understanding the complexity

of the research problem being addressed.


In order to provide an asset management perspective to the Transportation Planning and

Programming Division and the Right of Way Division, information regarding goals and

objectives, performance measures, options and trade-offs, required information, current analysis

methods, and implementation processes and practices are summarized in Table 3-2. The source

of reference for this information is “FHWA Asset Management Position Paper: White Paper”

(FHWA 2004).

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Table 3-2. TPP and ROW in Asset Management.

Transportation Planning and Programming Division Right of Way Division

Goals and Objectives

• cost-effectiveness • preservation of the existing system • mobility increase • accessibility increase • safety and security improvement • congestion relief • economic development • environmental protection

• cost-effectiveness of providing right-of-way for projects

• timeliness of providing right-of-way for projects

• minimizing cost of right-of-way acquisition

• minimizing risk of right-of-way acquisition

• compliance with federal and state law • cost-effectiveness of property

management while ensuring safety and environmental protection

• managing access to highway facilities Performance Measures

• level of service • travel time reliability • percentage of roadway lane-miles in good

or excellent condition • percentage of bridges that are structurally

sound • percentage of bridges on arterials without

weight restrictions • deferred maintenance expense • incident rates • incident response time • emissions • wetland acreage • community cohesion • life-cycle costs • user costs

• percentage of parcels acquired through negotiation

• length of property acquisition process and lead time required to close

• percentage of right-of-way costs spent on litigation

• percentage of construction costs associated with right-of-way acquisition

• average time needed to relocate residents

• average time needed to relocate businesses

• average payments • customer satisfaction surveys

Options and Trade-Offs

• among preservation, operations, and capacity expansion expenditures

• between passenger and freight mobility • among modal and intermodal options • among different geographic areas or

functional systems • balancing safety, mobility, environmental,

and equity objectives

• corridor location and alignments • timing of property acquisition and

disposal • incorporation of right-of-way activities

within design-build contracts • access management provisions • corridor management preservation

techniques • property management options and

practices Required Information

• socioeconomic data, including growth projections

• current traffic volumes and trip patterns • transportation supply characteristics • facility inventory, condition, and

performance • crash data • congestion/travel time • environmental data • vehicle fleet characteristics

• complete, accurate, and current information on property holdings

• real property and relocation costs by parcel, project type, and location

• time requirements for different project phases by project type and location

• environmental characteristics of parcels and mitigation needed

• success and risk factors assessment from past experience

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Table 3-2. TPP and ROW in Asset Management (Continued).

Current Analysis Methods

• travel demand modeling and traffic simulation

• infrastructure management methods • strategy impact assessment • benefit-cost analysis • air quality modeling

• scheduling • property acquisition cost estimation • revenue estimation • land valuation • geographic information systems (GIS)

analysis Implementation Processes and Practices

• long-range plan development and updates • corridor and regional planning • performance measurement and

monitoring • transportation improvement program

development • linkages among planning, programming,

and budgeting

• analysis of corridor development, preservation options, and joint development opportunities in long-range planning

• estimation and updates of right-of-way needs, costs, and mitigation requirements

• planning and scheduling of right-of-way acquisition to allow sufficient time for completion before construction

• operations and maintenance of right-of-way


Right-of-way acquisition is an essential part of the project development process. When a

project is initiated, it goes through various steps before the beginning of actual construction.

General steps in the project development process consist of planning and programming,

preliminary design, environmental clearance, right-of-way acquisition, and construction. Project

development is a time-consuming process and varies typically from 3 to 10 years. Among the

project development procedures, environmental clearance and right-of-way acquisition take up a

significant portion of the total time before construction.

The right-of-way acquisition process can be divided into five general phases (TxDOT

• Planning: This phase involves environmental studies and public involvement as well as

location and design studies. A new highway may require extensive environmental

studies, while a minor improvement on an existing road may only require a relatively

brief study.

• Appraisal: This phase deals with appraiser qualifications, appraisal requirements,

property evaluations, report formats, review responsibilities, etc.

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• Negotiation: This phase deals with local public agencies’ (LPAs) offers to acquire the

required property, prompt payment for such property, serve notices to vacate, assure

retention of improvements, etc. If the negotiations fail, the process moves into eminent

domain via condemnation proceedings.

• Property management: This phase deals with disposition of improvements acquired in the

purchase of right-of-way and methods for accomplishing the clearing of right-of-way.

• Relocation: This phase deals with making provisions for the fair and equitable treatment

of persons displaced as a result of federal or federally assisted and state programs in order

that such persons shall not suffer disproportionate injuries as a result of programs

designed for the benefit of the public as a whole.

Right-of-Way Procedures prior to Release

A summary of right-of-way procedures prior to release is included in this section. The

understanding of these procedures is important to propose a realistic approach for successfully

addressing the challenge posed in the research problem. The source of information for this

summary is the TxDOT ROW Manual (TxDOT 2006c).

Funding involves a sequence of consecutive steps from the time the right-of-way acreage

is being considered for acquisition until it is determined if there are enough funds to proceed

with the acquisition. The procedure to secure funding requires three steps as follows:

1. Determine right-of-way acreage needed.

2. Determine the approximate cost of acquiring needed right-of-way.

3. Determine the availability of funding at the local, state, and federal levels.

Planning and Sequence of Project Development

The planning of project development phase starts with actions preliminary to the right-of-

way acquisition process and ends with a contractual agreement. The sequence of project

development is described in the following steps:

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1. Actions preliminary to the right-of-way acquisition process: Right-of-way acquisition

requirements and information for obtaining Priority 1 authorization are discussed in the

TxDOT Project Development Process Manual (TxDOT 2003b). There is a targeted

percentage of right-of-way acquisition that should be complete for priority status, but the

percentage may vary depending on the size of the right-of-way project. To verify that a

project can be constructed as a Priority 1 status project, evaluate the project’s amount of

right-of-way acquired to date. This evaluation minimizes the possibility of right-of-way

acquisition delaying a letting and demonstrates the importance of involving ROW staff in

project development. Initial right-of-way acquisition is authorized when Priority 2

authorization is obtained. Priority 2 status is required for right-of-way acquisition

authorization. Long Range Project (LRP) status is obtained as the last and lowest level of

project development.

2. Sequence of right-of-way project development:

• Preliminary requirements (authorization must be deferred until these preliminary

requirements are complete):

a. The commission approves the program.

b. The schematics are approved.

c. Public involvement requirements are met (public hearing).

d. Environmental clearance is given.

e. Full release from the ROW and issuance of the General Expenditure occurs.

• The district is responsible to plan project development to completion:

a. Establish early coordination with utilities and railroads.

b. Acquire right-of-way.

c. Relocate displaced persons or businesses.

d. Remove improvements.

e. Coordinate required utility adjustments.

f. When negotiation is unsuccessful, eminent domain (ED) proceedings occur.

3. Project development meetings: The two meetings required for most projects are the

Preliminary Design Conference and the Design Conference. Each of these meetings

should allow sharing information and discussing right-of-way issues.

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4. Contractual agreement with LPAs: The Transportation Code, §203.051, authorizes

TxDOT to acquire whatever interest in any property that is needed for highway right-of-

way purposes. Usually, TxDOT will enter into an agreement with an LPA that

established responsibilities of each agency in the acquisition process. The Transportation

Code, §224.002, (TxDOT 2006c) states that an LPA must acquire highway right-of-way

as requested by TxDOT. The statutory authority allowing LPAs to contract with TxDOT

for acquiring needed right-of-way is found in the Transportation Code, §224.005. Terms

and conditions of any agreement entered into, by, and between TxDOT and an LPA are

determined between the parties. The Transportation Code, §224.005, provides that

TxDOT must reimburse an LPA not less than 90 percent of the cost of the right-of-way.

Right-of-Way Acquisition A description of types of project releases in right-of-way acquisition, advance acquisition

of right-of-way, and requirements and approval for advance acquisition by state legislators is

presented in this section.

Types of Project Releases

The types of project releases are:

• advance acquisition,

• limited release for utility investigation,

• limited release for appraisal work only,

• partial lease,

• full lease,

• limited release for relocation assistance only,

• limited release for utility work only, and

• release for preliminary engineering.

Advance Acquisition of Right-of-Way

Advance acquisition is defined as right-of-way acquisition that occurs before normal

release for acquiring right-of-way is given on a transportation project. Examples of advance

acquisition include the following:

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• Hardship acquisition is early acquisition of a parcel on a right-of-way project at the

property owner’s request to alleviate particular hardship to the owner. This does not

include hardship due solely to an inability to sell the property.

• Protective buying is early parcel acquisition to prevent imminent parcel development that

would materially increase right-of-way costs or tend to limit the choice of highway

alternatives. The parcel must be needed for a proposed transportation project.

• Donation is the acquisition of land for right-of-way purposes for no consideration, and

such acquisition must be in accordance with the provisions of Right of Way Donations

and Exchanges and Additional Requirements for Submissions for Advance Acquisition

through Donation.

General Requirements for Advance Acquisition by the State

There are general requirements to be met for advance acquisition by the state. The

general requirements for advance acquisition of right-of-way are:

• the status of environmental impact statement development;

• justification for the preferred alignment;

• the estimated date for normal right-of-way acquisition authorization;

• an appropriate segment of the schematic or right-of-way map, or a sketch of the parcel

involved; and

• the date on which TxDOT made a public announcement of the preferred location or the

status of the public hearing if federal funds are involved.

Other Types of Requirements for Advance Acquisition by the State

Some other types of requirements for advance acquisition of right-of-way by the state

• requirements for hardship acquisition submissions,

• requirements for protective buying submissions, and

• requirements for submissions for advance acquisition through donation.

Approval of Advance Acquisition by the State

Federal regulations and TxDOT policy and procedure necessitate these requirements.

However, fulfilling these requirements is not merely a matter of documentation. District

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personnel must possess personal knowledge of the situation in all advance acquisition cases to

complete submissions properly and to answer possible additional questions. Advance acquisition

must be approved by FHWA if federal funds are involved.

When advance acquisition is approved, ROW will issue a formal release, relating to the

specific advance acquisition parcel(s), to the district. The district may then proceed with the

advance acquisition.


The right-of-way acquisition process typically begins after environmental clearance is

obtained. The required parcels are identified, appraised, negotiated, and purchased from the

owners. The right-of-way acquisition could take place between point A and point B as shown in

Figure 3-6.

Figure 3-6. Right-of-Way Acquisition and the Project Development Process.

Generalization of the whole right-of-way acquisition process is difficult because the

acquisition process itself is a case-based specific process with many factors and conditions

involved. A schematic diagram of the right-of-way parcel acquisition process is shown in

Figure 3-7.

Planning and Programming

Preliminary Design

Environmental Studies


Plan, Specification & Estimate Development

Utility Adjustments

Project Initiation


(0.5-1 yr.)

(0.2-1 yr.)

(0.5-2 yr.)

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Project 0-5534

September 2006

eport 0-5534-1

Figure 3-7. Schematic D

iagram of R

ight-of-Way Parcel A


Planning & Design: Data Collection

Project Develop-ment

Environ-mental Clearance

Appraisal Present Offer

Signed Deed Track

Prepare Eminent Domain Track

Appraisal ValueChanged

Continue Eminent Domain Track


PrepareTrial Track


Judgmentin Absence of Objection Procedure

Accepted Changed

No Objection

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The different factors and potential scenarios during the right-of-way acquisition process imply a

great level of uncertainty and risk although it seems reasonable to assume that right-of-way land

price will increase over time. Nevertheless, the actual appreciation could be high or low

depending on the individual factors affecting the parcel to be purchased. For example, right-of-

way acquisition cost for a parcel at time T2 will be higher than the cost at time T1 for the same

parcel, as illustrated in Figure 3-8.

Figure 3-8. Right-of-Way Acquisition Cost versus Time.

On the other hand, the risk associated with purchase tends to decrease over time as the

right-of-way acquisition process proceeds and as shown in Figure 3-9.

Figure 3-9. Risk versus Time during Right-of-Way Acquisition Process.

Plots in Figures 3-8 and 3-9 are fictitious and are presented with the only purpose of

illustrating the concept. Cost and risk functions could be developed based on existing data and

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expert opinion. These functions could be used in simulation, optimization, or decision analysis

techniques. A simulation model could be built to generate possible outcomes from given

conditions considering cost and time spent over the right-of-way acquisition process.

Optimization techniques can be used to find optimal combinations of projects which minimize

total right-of-way cost while satisfying relevant constraints imposed by individual projects.

Decision analysis techniques can incorporate risk assessment through the right-of-way

acquisition process.

The following chapters present the approaches developed from each management science

perspective. Each approach proposed in this report is considered unique and has been

independently developed by small research groups. The content in the chapters represents the

vision of each research group to face the challenge described in this chapter. It is recommended

that the reader interpret the approaches independently. Comments regarding future steps based

on the proposed approaches are presented in the final chapter of the report.

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Dr. Richard M. Feldman and Dr. Dong Hun Kang are the authors of this chapter.

Dr. Feldman and Dr. Kang explore the potential application of simulation techniques to address

the right-of-way early acquisition question at TxDOT. Comments from the research team

management about the simulation approach are presented in Chapter 7: Conclusions and


The purpose of this chapter is to present our research plan for developing a simulation

tool that can be used to aid in the early right-of-way acquisition decision. Simulation is a

programming technique used for incorporating stochastic behavior into a system model. This

chapter contains a short description of the concepts behind event-driven simulations, gives the

specific objectives of the early acquisition simulation tool, lists the various project phases and

tasks needed for completing the development of the simulation, and provides an illustration

demonstrating that a deterministic model of a stochastic system can produce inaccurate results.

The model to be developed here will be a simulation of the Plan Authority and Develop

Authority phases of a TxDOT project. The output from the model will be potential actions

relating to early right-of-way acquisitions and a projection of expected annual costs for the

project plus their tail probabilities (20 percentile and 80 percentile points).


The decisions involved in acquiring right-of-way are a key feature to good asset

management, since asset management deals with the efficient allocation of funds for planning,

building, and maintaining the state’s transportation assets. For purposes of this chapter, right-of-

way acquisition will be considered within the context of a single project. We shall present here a

methodology for developing a tool that can be used for the optimal acquisition of the required

right-of-way necessary for the successful completion of a given transportation project.

The project development process is divided into four phases: Feasibility Study, Plan

Authority, Develop Authority, and Contract Authority. For purposes of this research effort, early

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acquisition of right-of-way is defined to be any effort to purchase right-of-way during the Plan

Authority phase of project development. In addition, early acquisition is defined to be either the

actual purchase of right-of-way (not currently possible) or the purchase of an option to buy right-

of-way within a proposed project corridor. Although the immediate purchase of property

without the use of an option to buy during the early acquisition phase is not currently permitted,

our methodology for determining an optimal right-of-way strategy should include this possibility

so that if the legislature permits direct early acquisition in the future, the tool will not become

immediately obsolete. Thus, our proposed methodology should produce a useful decision tool

whether or not options to buy are the only vehicle possible for early right-of-way acquisition.

There are two uses at the district level for our proposed early acquisition tool. The first

(and primary) use is during the Feasibility Study phase while proposed budgets are being

developed. Since right-of-way costs often account for 10–15 percent of a project’s budget,

savings for right-of-way can be significant and could be used either for other projects or to speed

the completion time of the current project. Thus, we suggest that determining the optimal

acquisition strategy during the initial planning phase of a project will help in the best use of

available funds. The second use of our tool is to help determine optimal use of project funds

when apparent (and unexpected) opportunities for early acquisition occur during the project

development phase. Because project development is a multi-year process, new information

regarding a potential sale or planned property improvement may be obtained that was not present

during project initiation. With new information will come the need to determine how best (most

economically) to use the new data. At the state level, the simulation tool that we are proposing

to build can be used for identifying and quantifying the general conditions under which the early

acquisition of right-of-way is beneficial.

Literature Review

A simulation is a technique to model physical or logical behavior of a system of interest

and evaluate the possible outcomes under various scenarios. Since simulation models often

possess high validity, which indicates the ability to reflect the real system, it sometimes is the

only option to model complex systems. They are also suitable to embrace stochastic variables

with enormous flexibility of probability distributions. However, simulation experiments are not

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guaranteed to generate optimal solutions and need statistical analysis to estimate the results from

the actual system.

Due to the complex nature of transportation engineering problems and simulation’s

ability to handle a wide variety of conditions in modeling, simulation is one of the popular

techniques in transportation research, from traffic demand modeling (Antoniou 1997) to

transportation infrastructure construction (Turkiyyah et al. 2005). In order to deal with complex

and uncertain conditions, many researchers adopt simulation methods in bridge management

systems (BMS) and pavement management systems (PMS), which could be considered

subsystems of transportation asset management systems (Hudson et al. 1987, Amekudzi 1999,

Amekudzi and McNeil 2000).

Sometimes simulation, as a leading or a supporting tool in decision-support systems,

works with other decision-supporting techniques such as optimization and decision analysis.

Even though simulation is very versatile in many cases, it cannot guarantee optimal solutions. In

order to overcome this drawback, simulation models sometimes include optimization techniques

as submodules to search optimal or near-optimal solutions during its computer experiments

(Hegazy and Kassab 2003, AbouRizk and Shi 1994). In contrast, some researchers have used the

simulation, as a supporting tool, to generate the most plausible scenarios from the problem

domain of large size and then solve the downsized problems by using optimization techniques

(Worzel et al. 1994, Consiglio and Zenios 1999, Seshadri et al. 1999).

To the best of the authors’ knowledge, there is very little research in simulation areas

directly related to the current research project of transportation asset management. Zhao et al.

(2004) developed a multistage stochastic model for decision making in highway development,

operation, expansion, and rehabilitation. In their model they considered underlying uncertainties

from traffic demand, land price, and highway service quality and used the Monte Carlo

simulation and least-squares regression as a solution algorithm. Table 4-1 shows the selected

literature of simulation in relation to the current transportation asset management project.

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Table 4-1. Selected Literature in Simulation.

Capturing Data and Model Uncertainties in Highway Performance Estimation

Adjo Amekudzi and Sue McNeil

2000 Analyzing data and analysis model uncertainties is one logical approach for addressing the information quality of infrastructure decision-support systems. This paper develops a computer simulation approach to explore the effects of data and model uncertainties on highway performance estimation. The results of the analysis illustrate that there are comparable data-induced and model-induced changes in both the expected value and the variability of highway performance estimates.

Uncertainty Analysis of National Highway Performance Measures in the Context of Evolving Analysis Models and Data

Adjo Amekudzi

1999 This research develops a simulation-based approach for uncertainty analysis of highway performance measures while addressing the impact of evolving analysis models and data within the highway DSS. The approach is applied to analyze changes, and associated risks, in the performance of a portion of the nation’s highway system.

4-003 A Method for Strategic Asset-Liability Management with an Application to the Federal Home Loan Bank of New York

S. Seshadri, A. Khanna, F. Harche, and R. Wyle

1999 They present a methodology to assist in the process of asset-liability selection in a stochastic interest rate environment. In their approach a quadratic optimizer is imbedded in a simulation model and used to generate patterns of dividends, market value, and duration of capital for randomly generated interest rate scenarios. The approach can be used to formulate, test, and refine asset-liability strategies.

4-004 Development of an Asset Management Strategy for a Network Utility Company: Lessons from a Dynamic Business Simulation Approach

Ivo Wenzler 2005 This paper suggests a dynamic business simulation—modeling and simulation approach based on system dynamics—to support development of asset management strategies at a couple of network utility companies. It uses a case study approach of a network utility company in the Netherlands to describe asset management dynamic business simulation (AMDBS) and its development process.

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Table 4-1. Selected Literature in Simulation (Continued). Item

4-005 Highway Development Decision-Making under Uncertainty: A Real Options Approach

Tong Zhao, Satheesh K. Sundararajan, and Chung-Li Tseng

2004 This paper presents a multistage stochastic model for decision making in highway development, operation, expansion, and rehabilitation. The model accounts for the evolution of three uncertainties, namely traffic demand, land price, and highway deterioration, as well as their interdependence. Real options in both development and operation phases of a highway are also incorporated in the model. A solution algorithm based on the Monte Carlo simulation and least-squares regression is developed.

4-006 Designing Portfolios of Financial Products via Integrated Simulation and Optimization Models

Andrea Consiglio and Stavro A. Zenios

1999 They analyze the problem of debt issuance through the sale of innovative financial products. They formulate a hierarchical optimization model. Input data for the models are obtained from Monte Carlo simulation procedures that generate scenarios of holding period returns of the designed products. The upper-level optimization program is multimodal, and a tabu search procedure is developed for its solution.

4-007 Integrated Simulation and Optimization Models for Tracking of Fixed-Income Securities

Kenneth J. Worzel, Christian Vassiadou-Seniou, and Stavros A. Zenois

1994 The paper develops an integrated simulation and optimization approach for tracking fixed-income indices. In an implementation of the model at Metropolitan Life Insurance Company, they introduce a simulation model for generating scenarios of holding period of returns of the securities in the index. Then they develop optimization models to select a portfolio that tracks the index. The models penalize downside deviations of the portfolio return from the index.

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Since environmental clearance has not been obtained, early acquisition decisions must be

made with respect to parcels of land that may or may not be within the final project corridor.

Thus, in the following, we consider all parcels of land that have a potential to be within the final

corridor and that satisfy at least one of the following conditions: (1) the land is for sale by the

current owner, (2) it is expected that the land will be for sale before the environmental clearance

is obtained, (3) improvement activities have begun on the land by the current owner, and (4) it

appears likely that improvement activities will begin on the land before the environmental

clearance occurs. Before proceeding with our discussion, a further description is necessary with

respect to improvement activities since this is the most common reason why early acquisition

should be considered. When property is acquired, the state must pay the owner a fair market

value of the land plus any damages to the remainder of the land, if any, plus relocation costs of

people and utilities. Thus, improvements to land that occur during the early acquisition period

not only increase the value of the land itself but could significantly increase the cost of damages

to the remainder and relocation costs. The main question of interest is whether or not the

expected improvements are significant enough to justify early acquisition.

Right-of-way must either be acquired early or on time (on time refers to the acquisition

after the environmental clearance is obtained, i.e., during the Develop Authority phase of the

project). In what follows, a listing of the costs associated with early acquisition and on-time

acquisition is given. However, once a decision has been made to pursue early acquisition for a

parcel of land, it does not necessarily follow that the parcel will be purchased through early

acquisition. In other words, a decision may be made to pursue early acquisition, but the land

owner and the state cannot come to a mutually agreeable contract; thus, the effort for early

acquisition yields time and effort but no land. Our goal is to build a simulation model of the

project development process that includes all major stochastic events. The purpose of the

simulation model is to minimize the expected value of the total discounted project cost and to

predict best- and worst-case scenarios of project costs based on the stochastic inputs. In order to

minimize costs, we must understand the various cost trade-offs.

The major costs associated with early right-of-way acquisition are: (1) the market value

of the parcel at time of purchase, (2) damage costs to the remainder if applicable, (3) the cost of

the option to buy if an option to buy was used, and (4) the cost associated with having property

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not used by the project in the case that the early acquisition involved a parcel of land not

contained within the final approved alignment. Item 4 may be intentional or not. For example, if

there are several choices in the final alignment of the project, it is possible that multiple parcels

could be purchased early, knowing that only one from the set will be required for the project. Or

it is possible that a parcel is purchased with the expectation that it will be used, but during the

environmental clearance process the alignment is changed from what was expected. Thus, our

model must include the probability of changes in project alignment during the environmental

clearance process.

The major costs associated with on-time acquisition are: (1) the market value of the

parcel at the time of purchase, (2) damage costs to the remainder if applicable, (3) additional

costs due to legal proceedings if condemnation proceedings are necessary, and (4) delay costs

associated with not having a parcel of land in a timely fashion. When early acquisition is

considered because the owner has placed the parcel on the open market, then the second, third,

and fourth potential costs for on-time acquisition are avoided. When early acquisition is

considered because of known or expected property improvement, then the first two costs

associated with on-time acquisition are likely to be significantly higher, and thus the probability

associated with incurring the third and fourth costs is also significantly increased.

In addition to the above costs, there are also time constraints that must be modeled. This

includes not only the normal project time constraints, but also the constraint in being able to

pursue a limited number of parcels through early acquisition. As discussed below in the

“Research Plan” section, the goal of the activity analysis tasks of our research is to identity the

costs and time constraints relevant to a project, and the data analysis and economic analysis tasks

are designed to provide estimates for those values.


Simulation is a modeling approach for stochastic (i.e., probabilistic) systems. The goal of

a simulation model is to build a computer-based representation of a system in such a way that

each run of the simulation program reproduces a statistical experiment of system output. For

example, suppose we would like to simulate a highway project that includes building a 5-mile

stretch of highway, and part of the model includes the completion time of the 5-mile section.

Although 18 months is the estimated duration time for this part of the project, looking at

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historical records of similar projects, it is observed that 10 percent of the time the completion

took 16 months, 20 percent of the time it took 17 months, 40 percent of the time it took

18 months, 20 percent of the time it took 19 months, and 10 percent of the time it took 20

months. When modeling this project, the computer would generate a single random number to

represent completion time so that if the simulation was executed 100 times, the random number

would be such that the value of 16 would occur approximately 10 times, the value of 17 would

occur approximately 20 times, etc.

Let us expand on this example. Work on the 5-mile section will begin at the start of

January and so is expected to finish at the start of July the following year. After the 5-mile

section is finished, the second phase begins. If the 5-mile section finishes in May, the next phase

will take either 5 or 6 months with certain probabilities. If the 5-mile portion finishes in June,

the next section will be completed in 5, 6, or 7 months with certain probabilities. And so on until

we have the case that if the 5-mile section finishes in August, the next section would take 6, 7, or

8 months. In other words, the length of time to complete the second section depends on the time

of year so that there are statistical dependencies within the model. Thus, it has now become a

little more complicated to determine the expected finish time for the entire project because of

these dependencies. By generating two random numbers to represent the completion times for

the two phases, the simulation model could be run 100 times and an expected completion time

for the entire project determined. Or, sometimes equally important, the simulation could be run

100 times to determine the probability that the completion time will be longer than some

predetermined threshold value. (These are called tail probabilities, which represent the

probability of a project taking “too long” to complete.)

Of course, even for the second example, it would not be difficult to determine both the

theoretical expected value and the theoretical tail probabilities. However, in a realistic project

with many different sources of randomness and with complex statistical dependencies, it is

impossible to determine theoretical expected values; thus, simulation becomes an invaluable

modeling tool to determine system characteristics. By generating 100 different scenarios (i.e.,

100 separate statistical experiments) and their associated costs, it becomes possible to estimate

an expected value for project costs by taking an arithmetic average of the 100 realizations and, in

addition, give some sense of the possible variations in project costs by looking at 80 percentile

and 20 percentile extremes.

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It is quite common to model processes using average values, thus creating deterministic

approximations of models of processes that are inherently stochastic. Before proceeding with

our research plan, it will be helpful to emphasize the importance of including statistical

variations within a model since deterministic representations of stochastic processes can easily

yield incorrect decisions.

To illustrate the importance of stochastic modeling, we consider a simplified example of

project planning. Consider a project that includes three tasks. Tasks 1 and 2 are carried out

simultaneously, task 3 starts as soon as both task 1 and 2 are completed, and our interest is in

predicting the start time for task 3. Assume task 1, with equal probabilities, takes either 2 or

4 months to complete and task 2 always takes 3 months. If we use averages, each task takes

3 months to complete, and thus the average start time for task 3 would be 3 months. However,

when you consider the randomness of task 1, a different average commencement time for task 3

is obtained by the following reasoning. Fifty percent of the time, task 1 takes 2 months, which

implies that the start time for task 3 is 3 months due to the length of time to complete task 2.

Fifty percent of the time, task 1 takes 4 months to complete, which implies that the start time for

task 3 is 4 months. The average of those two values yields an expected start time for task 3 of

3.5 months (thus an error of 14 percent). (See Figure 4-1 for a schematic illustrating these

Figure 4-1. Comparison of Deterministic and Stochastic Project Scheduling.

(a) Deterministic model using averages (b) Stochastic model considering randomness

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Inaccuracies from deterministic approximations are further exacerbated when costs are

nonlinear. Assume that the cost of the project is roughly proportional to the square of the time at

which task 3 starts. The deterministic approximation would yield a cost of 9 units, whereas the

actual average is a cost of 12.5 units (namely, the average of 9 and 16). Thus, the average cost

estimate from the deterministic approximation yields an error of almost 39 percent.

The two common goals of a model are to predict expected values and to estimate tail

probabilities. Obviously, a deterministic model is incapable of estimating tail probabilities, and

the simple example above shows that even with only slight variations, the accurate prediction of

expected values requires a stochastic model.


Our objective is to develop a computer-based stochastic model for project costs and

completion times that will contain a decision-support submodel for optimizing the early

acquisition of right-of-way (see Figure 4-2 for a schematic diagram illustrating the logic flow for

a simulation-based decision-support system). This stochastic model will be a simulation of the

project with the intent that it can be used during both the Feasibility Study phase of project

development and the Plan Authority phase of project development. The simulation could be

used tactically at the district level during the Feasibility Study phase to help in estimating total

project costs and suggesting which parcels of land should be targeted for early acquisition. It

could also be used during the Plan Authority phase to help in making early acquisition decisions

when additional information regarding potential right-of-way land becomes available. It would

also be possible to use the simulation strategically at the state level to provide guidelines for

potential savings in project costs associated with early right-of-way acquisition and the possible

effect of shifting funds from one phase of the project to additional early acquisition efforts.

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Figure 4-2. Schematic Diagram of Simulation-Based Decision-Support System.

In a slightly simplified view of simulations, there are two types: Monte Carlo

simulations and event-driven simulations. A Monte Carlo simulation refers to a model in which

random variates are created to reproduce a statistical experiment in which time is not a factor.

Models developed to represent a stochastic process involving time often use an approach called

event-driven simulations. The “event-driven” part of the simulation refers to the mechanism by

which the simulated clock is handled. There are other types of mechanisms for maintaining the

simulated clock, but for the purposes of this project, it is the event-driven simulation that we

shall use. (See Feldman and Valdez-Flores [1996] for a brief description of event-driven


The deliverable from this project will be an event-driven simulation of project

development that includes a decision submodel together with a branch-and-bound or other

combinatorial type algorithm to assist in the right-of-way early acquisition decision. The output

of the model will be a projection of expected annual expenses associated with the project plus

best- and worst-case scenarios representing likely variations in expenses due to random events.

(Best- and worst-case scenarios refer to the tail probabilities of cost expenditures associated with

the 20 percentile and 80 percentile points.) The model should also be able to predict the

expected completion times for the major milestones of a project. Because the Construct

Authority phase cannot begin until right-of-way has been purchased and early acquisition is not

feasible until the project enters the Plan Authority phase, the simulation model will include only

the Plan Authority and the Develop Authority phases.

Simulation Model

Decision Submodel

Asset Management Decision-Support System

Inputs Total Project Costs Project Completion Times

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There will be four major phases to this project, with each phase containing multiple

activities. These phases are (1) “as-is” model development for projects with no early acquisition,

(2) “to-be” model development that includes early acquisition options, (3) integration of the

decision-support and optimization submodels for use within the simulation, and

(4) verification/validation. In what follows, we look at each of these phases separately.

“As-Is” Model Development

Before the early acquisition of right-of-way can be considered beneficial, it is essential to

understand and accurately estimate costs incurred and time requirements associated with a

project that does not include any early right-of-way acquisitions. The steps to be carried out

during the “as-is” development phase are (1) development of the model framework, (2) activity

analysis, (3) data analysis, (4) economic analysis, (5) model integration, and (6) model


One of the issues that must be decided before development of the model framework can

begin is to choose a programming platform. There are several excellent simulation language

packages available for model development, such as Arena by Rockwell Software, Inc.; ProModel

by ProModel Corporation; Witness by Lanner Group, Inc.; etc. There are at least two advantages

commonly attributed to the use of one of these specialized simulation languages. First,

simulation models are quicker to develop if a simulation package is used instead of a

programming language. Second, simulation is more accessible to researchers since good

programming skills are not required for the use of these simulation packages. However, there

are also two major disadvantages. First, a model developed in a commercial simulation language

is not very portable (i.e., cannot be easily moved to computers without the purchase of the

software package). Second, the language is not very flexible for building unusual features into

the model. A third disadvantage which may or may not be relevant is that a model built using a

general-purpose language will run faster than a model built with a simulation language. For

these reasons, our suggestion is to use VB.NET, which will allow extremely flexible models

including the ability to integrate decision-support and optimization routines. In addition,

Windows®-based models can be developed to include menus, dialog boxes, etc., and programs

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built using VB.NET can be executed from any computer running Microsoft Windows XP® and

can be ported to a web-based system.

This research will begin with the first two steps (development of the model framework

and activity analysis) followed by the next two steps (data analysis and economic analysis). That

is, we will immediately begin with developing the “as-is” model framework and at the same time

start the activity analysis. The TxDOT activities carried out during Plan Authority can be

categorized into four types: planning and programming, preliminary design, environmental, and

right-of-way and utilities. The activities carried out during Develop Authority are categorized

into either right-of-way and utilities or planning, specification, and estimation development.

During the activity analysis step, each activity under these categories must be analyzed to

determine time span, cost factors, and precedent relationships. The identification and description

of the activities are accomplished through in-depth discussions between personnel from the

research team and TxDOT personnel. At this time unknown factors will be clearly identified.

Values for the unknown factors will be estimated during the data analysis step. The impact of

the cost factors on the budget process and their potential for inflation and appreciation (i.e.,

increase in land value due to improvement activities by the owners) will be identified and

described during the economic analysis step. Thus, a key function of activity analysis is to

identify actions to be taken during the data analysis and economic analysis steps. The model

integration step will use the information from the analysis steps to “tune” the model so that it

reflects reality. The model verification/validation step refers to the verification function where

the researcher seeks to ensure proper model development and then demonstrates the model to

TxDOT personnel for their feedback during model validation. Although we list these steps

linearly, there is actually feedback from the verification/validation step to the model integration

step where we would expect significant changes in the model after it is demonstrated to TxDOT

A major function of the economic analysis step that will require a significant amount of

research is to assign possible appreciation factors to parcels of land that are likely to be improved

by the land owner. The purpose of the simulation is to predict completion times and cost factors

for a project several years in advance of scheduled project completion. For right-of-way

acquisition, each parcel of land that may potentially be needed must be identified. Estimates for

the cost of the land based on one or more likely scenarios that the land owner may begin land

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improvement before the Develop Authority phase of the project development process is reached

must be made. These should not be deterministic values; a range of possible values should be

estimated together with estimated probabilities. In addition, the likelihood that delays in land

acquisition due to the necessity of using condemnation to acquire the property must be estimated.

Although these are clearly random factors, some effort will be spent in identifying the

appropriate probability laws to use for best describing this process.

“To-Be” Model Development

The steps for the “to-be” development phase are the same as in the previous phase except

that the focus will be on describing, in probabilistic terms, the various possible scenarios for

early acquisition. In this phase, it will be assumed that the decision to attempt an early

acquisition of right-of-way is fixed. In other words, part of the input to this model will be the

decision for each parcel of land concerning whether or not to pursue early acquisition. The data

will also include probabilities associated with a parcel of land actually being used for the right-

of-way, probabilities associated with the early acquisition effort being successful, and

probabilities associated with differing improvement scenarios by the land owner. It is likely that

this will be the most difficult and time-consuming task of this research effort. As described

previously, there are four key costs associated with the early right-of-way acquisition, namely

market value of land subject to early acquisition, damage costs, cost of the option to buy, and

cost of purchased property not being used. To further complicate the analysis, these costs are not

constant with respect to time; however, without some estimate of these costs, it will be

impossible to determine the trade-off between early purchase and on-time purchase. We expect

to use both the personal experiences of TxDOT personnel as well as the investigation of

historical records to provide estimates for these costs. Sensitivity studies will also be performed

to determine acceptable bounds for these costs.

Another aspect of the model that will be important is the ability to update information

and easily rerun the model for improved predictions. Our vision is that this model will be used

during the Feasibility Study phase of project development to obtain projections for project costs

and time constraints. However, it is likely that during the Plan Authority phase of project

development new information regarding the potential for land improvement will become known.

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At that time, the model will be used again to determine the effect of a changed early acquisition

decision in light of the new information.

Integration of the Decision-Support and Optimization Submodels

The purpose of the simulation model is to give accurate estimates of stochastic events and

assist in decision making. Thus, a decision-support module would be required as part of the

software system. This decision-support module will incorporate the research efforts described in

the chapters dealing with optimization and with decision and risk analysis.


Program verification is the step whereby the software is checked to ensure that it was

programmed accurately (namely, if the model calls for addition, terms were actually added and

not accidentally subtracted). The major step in program verification is tedious but not difficult.

It involves developing some scenarios that are worked out by hand and duplicated with the

Model validation is more difficult. Validation is the step in which the model is checked

to ensure that it conforms to reality. Although validation is difficult, it is extremely important

because without it, there is no real justification for using the software. The principal method of

validating software is to demonstrate the software system to knowledgeable personnel to obtain

feedback and confidence in the various assumptions that are part of the modeling effort. Thus,

after each major step in development is complete, a demonstration will be made to TxDOT

experts for their feedback.

It is important to test each piece of the model as it is developed and also to test the fully

integrated model. This is the reason that verification/validation is listed under each step of the

research plan in addition to being a separate step itself.


The most difficult and time-consuming steps in this research will be the data analysis and

economic analysis for the various activities that are identified during the activity analysis step of

“as-is” model development and “to-be” model development, and these tasks are discussed in

more detail in other sections of the report. The simulation tool will involve four key features:

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(1) a graphical interface to allow easy input of project data, (2) an Access® database input system

containing the results of the data analysis and economic analysis efforts, (3) a simulation model

designed to produce statistical estimates for annual costs and completion times, and (4) a

graphical interface to view and help interpret the simulation results. The graphical interfaces

will be Windows-based systems familiar to most personal computer (PC) users. Their specific

features cannot be determined ahead of time and will be designed during the model framework

development steps; however, the general process of designing a user interface has been described

by Pressman (2001) and is usually a very time-consuming part of software development.

Pressman describes the process of developing the user interface as:

1. user, task, and environment analysis and modeling;

2. interface design;

3. interface construction (implementation); and

4. interface validation.

The development process implies that each of these tasks will occur more than

once, with each pass requiring additional elaboration of requirements and the resultant

design. In most cases, the construction activity involves prototyping and usability

analysis—the only practical way to validate what has been designed (Pressman 2001).

In this section, we shall describe in slightly more detail the modeling approach mentioned

in the “Objectives for the Simulation Model” section; namely, we explain the application of an

event-driven simulation to the development of the simulation we envision for helping with the

early acquisition decision. Two definitions are important: an activity is something that occurs

over a (possibly random) time period and that has the potential to influence project costs and/or

project completion time, and an event is the completion time of an activity or something that

causes a state of the system to change. There are both project activities and events as well as

external activities and events. For example, a project activity might be the development of

compliance and planning requirements, and an event might be the completion of the compliance

and planning requirements. An external activity might be improvement tasks being undertaken

by a private land owner. An activity always creates an event by its completion, but an event may

occur that is not tied to an activity. For example, notification that a land owner would like to sell

property under the hardship provision for early acquisition would be an event not related to the

completion of an activity. Most project activities are initiated by the completion of other

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activities, and most external activities are initiated by an event. For example, the activity of a

land owner undertaking some improvement task would be initiated by an event instead of the

completion of another activity. The event identified by “begin improvement task” would be

created at a random point in time according to a probability law identified during the data

analysis step, with the possibility that the event is never created.

To begin the simulation program, a list of all possible activities is created, and a list of all

possible events not associated with the completion of an activity is created. (One of the goals of

the activity analysis task of this research effort is to identify all relevant activities and events for

the simulation. With today’s computer power, there should be no upper limit on the number of

activities and events that can be used for the simulation. In other words, as long as data can be

found that will permit an activity and event to be described, it will be incorporated into the

simulation model.) Each activity has an associated list of immediate predecessor activities. To

illustrate, assume we have a project involving seven activities with the precedent relationships

shown in Figure 4-3. Further assume there is one external activity (identified by Activity #8)

which is initiated by Event #8. Thus, for example, Activity #3 is initiated by the completion of

Activity #1, and Activity #6 is initiated when both Activities #3 and #4 are complete. For ease

of notation, we shall say that Activities #1 and #2 are initiated by Event #0.

Figure 4-3. Illustration of an Event and Activity Diagram.

Activity #1

Activity #4

Activity #3

Activity #2 Activity #6

Activity #7Activity #5

Activity #8

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A simulation maintains a simulation clock indicating the day, month, and year within the

simulation and a calendar list of future events, which is a list of all known future events plus the

time at which the events are scheduled to occur. Simulation initiation places Event #0 on the

future events calendar plus any potential external events that may occur and do not depend on

another event or activity. Events are then removed one at a time from the calendar list, and the

simulation clock is advanced. Random variates are generated according to the event being

removed from the list, and future events are created and placed on the calendar. To illustrate

from the above diagram, Event #0 is placed on the calendar and scheduled to be removed at

time 0. A random variate is generated representing the time Event #8 will occur, and then

Event #8 is placed on the future events calendar. When the simulation starts, Event #0 is

removed, and it initiates the creation of two random variates representing the duration of time to

be taken by Activities #1 and #2. At this point, the two events representing the completion times

of Activities #1 and #2 will be placed on the future events calendar and are scheduled to be

removed at their randomly created times. Any cost factors are updated based on the two

activities. The next event to be removed from the future events calendar will be the event with

the minimum scheduled time of removal from the three events (Events #8, #1, and #2) now on

the calendar. When the next event is removed, the simulation clock is advanced to the time of

removal, an activity is started if possible, costs are updated, new random variates are generated,

and new events are placed on the future events calendar.

To continue this illustration, assume we randomly generated a time indicating that

Event #8 is scheduled to occur after 8 months, Activity #1 is scheduled to last 5 months, and

Activity #2 is scheduled to last 4 months. Thus, Event #2 (i.e., the completion of Activity #2) is

next removed from the future events calendar, and the clock is advanced 4 months. Event #2

signals the initiation of Activities #4 and #5, so random variates are generated representing their

duration. Notice that if the factors influencing the length of the activity depend upon the time of

year, then the time of year is easily taken into account because an activity’s duration time is not

generated until it is known (in a statistical sense) when activity starts. Once the durations of the

two activities are randomly generated, those completion time events are placed on the future

events calendar. The next event is then removed from the future events calendar, and the clock

is again updated. In this fashion, the simulation clock continues to advance until project


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Because it is events that control the simulation clock, this type of simulation is called an

event-driven simulation. Using this approach, we expect to design a program that can be used to

predict the costs and the timings associated with TxDOT projects with and without the early

acquisition of right-of-way.


Because of the presence of multiple sources of stochastic variations in project

development, it is essential that simulation be included in any tool whose purpose is to predict

project costs. The task of developing a simulation useful for predicting project costs and aiding

in the early right-of-way acquisition decision is made difficult by the presence of a significant

number of unknown time and cost factors relevant to early acquisition. It will be the goal of the

activity analysis, data analysis, and economic analysis tasks to identity and estimate these

factors. Although there is no (or very little) history from which to draw reliable estimates since

early acquisition has not been used in Texas (ignoring the little-used emergency cases), we do

expect to obtain “ballpark” estimates that can be used in our initial modeling efforts. Then as

more experience is gained, these estimates can be improved.

It is our expectation that the completed simulation tool as described in this chapter will be

useful at both the district and state levels. At the district level, it will enhance project planning.

At the state level, it will enhance policy making by allowing the improved analysis of

implementing potential early right-of-way acquisition strategies.

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Dr. Illya V. Hicks and Dr. Sergiy Butenko are the authors of this chapter. Dr. Hicks and

Dr. Butenko explore the potential application of optimization techniques to address the right-of-

way early acquisition question at TxDOT. Comments from the research team management about

the optimization approach are presented in Chapter 7: Conclusions and Recommendations.

This chapter discusses optimization-based approaches to resource allocation problems

arising in TxDOT practice, in particular related to right-of-way acquisition. It first gives a brief

introduction to the area of optimization and its major research directions and developments. It

then describes the data collection and processing procedures, at both district and division levels,

required for successful completion of the proposed project. Two alternative optimization

approaches for optimal resource allocation are proposed: the top-to-bottom and the bottom-to-top

approaches. The first approach uses two different types of models to first allocate the budget

between districts at the division level, and then solve a smaller-scale resource allocation problem

for each district to select specific projects. The second approach uses the same detail-involved

model designed for districts at the division level to allocate the budget between projects within

the division and then uses the results to allocate the resources between districts. Finally, expected

outputs and extensions of the proposed work are outlined.

Optimization has been expanding in all directions at an astonishing rate during the last

few decades. New algorithmic and theoretical techniques have been developed, the diffusion into

other disciplines has proceeded at a rapid pace, and our knowledge of all aspects of the field has

grown even more profound (Floudas and Pardalos 2002, Pardalos and Resende 2002). At the

same time, one of the most striking trends in optimization is the constantly increasing emphasis

on the interdisciplinary nature of the field. Optimization today is a basic research tool in all areas

of engineering, medicine, and the sciences. The decision-making tools based on optimization

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procedures are successfully applied in a wide range of practical problems arising in virtually any

sphere of human activity.

Resource allocation problems are among classical applications of optimization

techniques. However, the complexity of real-world problems associated with resource allocation

in transportation infrastructure limits the applicability of classical methods, making one seek

novel approaches. While there are a number of research papers describing applications of various

mathematical programming methodologies to resource allocation problems, they cannot be

applied directly to the decision-making situations arising in TxDOT practice. On the other hand,

the rich body of literature on the subject provides indisputable evidence of the effectiveness of

optimization techniques in solving resource allocation problems in general. Indeed, recent

progress in algorithmic techniques coupled with improvements of computer hardware have led to

the development of software packages capable of handling instances of optimization problems of

unprecedented scales. Given these developments and the variety of factors involved in resource

allocation problems faced by TxDOT, proper mathematical models become the key to success in

dealing with these problems. In this regard, one needs to find a good balance between the amount

of detail included in the model and the complexity of the resulting model. Typically, the

mathematical models that better describe the system (e.g., stochastic mixed integer nonlinear

programming) are much more involved computationally than simple models such as linear

programming. However, sometimes even very basic models approximating the system of interest

provide reasonable results. Thus, extensive experimentation and sensitivity analysis are often

used to determine the proper models.

Depending on the nature of the problem, different techniques can be used to formulate

and solve a typical optimization problem. Linear programming deals with optimization

problems, in which the objective and constraints can be formulated using only functions that are

linear with respect to the decision variables. In nonlinear optimization, one deals with optimizing

a nonlinear function over a feasible domain described by a set of, in general, nonlinear functions.

The pioneering works on the gradient projection method by J. B. Rosen (Rosen 1960, 1961)

generated a great deal of research enthusiasm in the area of nonlinear programming, resulting in

a number of new techniques for solving large-scale problems. This research resulted in several

powerful nonlinear optimization software packages, including MINOS (Murtagh and Saunders

1983) and Lancelot (Conn et al. 1992).

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In many practically important situations in linear as well as nonlinear programming, all or

a fraction of the variables are restricted to be integer, yielding integer or mixed integer

programming problems. These problems are in general computationally intractable, and it is

unlikely that a universal “fast” (polynomial-time) algorithm will be developed for integer

programming. Linear and integer programming can be considered special cases of a broad

optimization area called combinatorial optimization. In fact, most of combinatorial optimization

problems can be formulated as integer programs. The most powerful integer programming

solvers used by modern optimization packages such as CPLEX (ILOG 2001) and Xpress (Dash

Optimization 2001) usually combine branch-and-bound algorithms with cutting plane methods,

efficient preprocessing schemes including fast heuristics, and sophisticated decomposition


In many optimization problems arising in resource allocation, as well as other

applications, the input data, such as demand or cost, are stochastic. In addition to the difficulties

encountered in deterministic optimization problems, the stochastic problems introduce the

additional challenge of dealing with uncertainties. To handle such problems, one needs to utilize

probabilistic methods alongside optimization techniques. This led to the development of a new

area called stochastic programming (Prekopa 1995), whose objective is to provide tools to help

design and control stochastic systems with the goal of optimizing their performance.

Due to the large size of most practical optimization problems, especially of the stochastic

ones, the so-called decomposition methods were introduced. Decomposition techniques (Lasdon

1970) are used to subdivide a large-scale problem into subproblems of lower dimension, which

are easier to solve than the original problem. The optimal solution of the large problem is then

found using the optimal solution of the subproblems. These techniques are usually applicable if

the problem at hand has some special structural properties. For example, the Dantzig-Wolfe

decomposition method (Dantzig and Wolfe 1960) applies to linear programs with block diagonal

or block angular constraint matrices. Another popular technique used to solve large-scale linear

programs of special structure is Benders decomposition (Benders 1962). One of the advantages

of the decomposition approaches is that they can be easily parallelized and implemented in

distributed computing environments.

The advances in parallel computing, including hardware, software, and algorithms,

increase the limits of the sizes of problems that can be solved (Migdalas et al. 1997). In many

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cases, a parallel version of an algorithm allows for a reduction of the running time by several

orders of magnitude compared to the sequential version. Recently, distributed computing

environments were used to solve several extremely hard instances of some combinatorial

optimization problems, for instance a 13,509-city instance of the traveling salesman problem

(Applegate et al. 1998) and an instance of the quadratic assignment problem of dimension 30

(Anstreicher et al. 2002). The increasing importance of parallel processing in optimization is

reflected in the fact that modern commercial optimization software packages tend to incorporate

parallelized versions of certain algorithms.

As a result of ongoing enhancement of the optimization methodology and of

improvement of available computational facilities, the scale of the problems solvable to

optimality is continuously rising. However, many large-scale optimization problems encountered

in practice cannot be solved using traditional optimization techniques. A variety of new

computational approaches, called heuristics, have been proposed for finding good suboptimal

solutions to difficult optimization problems. A heuristic in optimization is any method that finds

an “acceptable’’ feasible solution. Many classical heuristics are based on local search

procedures, which iteratively move to a better solution (if such solution exists) in a neighborhood

of the current solution. A procedure of this type usually terminates when the first local optimum

is obtained. Randomization and restarting approaches used to overcome poor-quality local

solutions are often ineffective. More general strategies known as metaheuristics usually combine

some heuristic approaches and direct them towards solutions of better quality than those found

by local search heuristics. Heuristics and metaheuristics play a key role in the solution of large,

difficult, applied optimization problems. Sometimes in searching for efficient heuristics people

turn to nature, which seems to always find the best solutions. In recent decades, new types of

optimization algorithms have been developed and successfully tested, which essentially attempt

to imitate certain natural processes. The natural phenomena observed in annealing processes,

nervous systems, and natural evolution were adopted by optimizers and led to the design of

simulated annealing (Kirkpatrick et al. 1983), neural networks (Hopfield 1982), and evolutionary

computation (Holland 1975) methods in the area of optimization. The ant colony optimization

method is based on the behavior of natural ant colonies. Other popular metaheuristics include

greedy randomized adaptive search procedures (GRASP) (Feo and Resende 1995) and tabu

search (Glover and Laguna 1997). Some of the previous research (e.g., Siethoff et al. 2002)

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attempted to address the question of whether right-of-way should be acquired early. The authors

of this report believe that there is no definitive answer to this question in general, and rather the

question should be addressed on a case-by-case basis. Optimization models and techniques

discussed in this chapter provide a valuable tool in this regard. The following sections of this

chapter present how these techniques may be applied to help TxDOT answer this question.

Literature in Relation to Transportation Asset Management

Efficient allocation of resources is a critical component of successful transportation asset

management practice. Many optimization techniques have played an important role as a

decision-support system in various areas of resource allocation problems. Notably, research into

optimal fund (or budget) allocation has been actively pursued for general project management

(Hegazy 1999), for multidistrict highway agencies (Chan et al. 2003), for purchasing buses

(Khasnabis et al. 2003), and for infrastructure projects (Gabriel et al. 2006).

Pavement management systems and bridge management systems have been well-

established areas of transportation infrastructure management during the early stage of asset

management. Due to the increase of traffic demand, capital budgeting problems in highway

maintenance have drawn the attention of many researchers. Since optimization is a mathematical

approach which minimizes cost or maximizes benefit while satisfying pre-given constraints, it is

adopted for many transportation problems including the capital budgeting problem. Armstrong

and Cook (1979) developed a model for a single-year planning period. In the model the objective

was to maximize the total benefit from the highway subject to fixed budget constraints. Later it

was expanded to consider multiple planning years by using a financial planning model and a goal

programming approach (Cook 1984). In contrast to maximizing benefit, another approach is to

seek a solution minimizing total costs. Davis and Van Dine (1988) developed a computer model

to minimize user costs subject to budget and production capacity for optimizing maintenance and

reconstruction activities. They used linear programming formulation as an optimization

technique. More recently, advanced computing power allows optimization techniques to solve

more realistic and sophisticated PMS problems, which is a part of a larger decision-support

system. Ferreira et al. (2002) formulated a mixed integer optimization model for network-level

PMSs. They used genetic-algorithm heuristics to solve the optimization problem, minimizing the

expected total discounted costs of pavement maintenance and rehabilitation actions over a

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planning period. Wang et al. (2003) also used genetic-algorithm heuristics to solve the zero-one

integer programming formulation of PMSs.

Often transportation projects have to be evaluated in accordance with multiple criteria,

such as benefits and drawbacks of different stakeholders such as the general public, DOTs,

districts, counties, and MPOs. Furthermore, such projects have to deal with a wide range of

assets, such as pavements, bridges, roadsides, and right-of-way with uncertainty implications.

Even though tradition optimization deals with single-objective deterministic systems, there are

also many attempts to solve problems with multiple objectives and/or uncertainty. Two different

approaches are generally used for solving multiple-objective decision-making problems. First, in

some cases, multiple objectives can be aggregated into a single-objective function. Multiple

objectives are ranked according to the preference of the decision maker, and suitable weights are

assigned to the objectives. Since the resulting formulation is usually a nonlinear and

combinatorial optimization problem, heuristic solution techniques are used. One of the widely

used heuristic methods in transportation and infrastructure engineering fields is the application of

genetic algorithms (Hegazy 1999, Chan et al. 2003). Hsieh and Liu (1997) proposed a three-

stage approach of initial portfolio construction, portfolio finalization, and final portfolio and plan

determination to solve a zero-one, nonlinear, multiple-objective knapsack selection problem.

An alternative way of solving multiple-objective problems is to consider the individual

objectives simultaneously in the mathematical formulation. Goal programming can be used in

instances where the preset service level should be achieved in multiple-objective situations.

Cook (1984) applied goal programming to the capital budgeting problem in the area of highway


Management of transportation assets inevitably involves various uncertainties such as

deterioration of pavement and bridges, unexpected change of fund and project schedule,

fluctuating traffic demands over time and locations, etc. In order to deal with the uncertainties,

probabilistic optimization models are developed by many researchers. Some of them used state

transition probability to consider pavement condition changes (Davis and Van Dine 1988,

Ferreira et al. 2002). Others (Gabriel et al. 2006) used probabilistic constraints related to the

available budget for determining an efficient budget allocation for a portfolio of infrastructure

projects. Table 5-1 shows the selected literature of optimization in relation to transportation asset


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Table 5-1. Selected Literature in Optimization.

5-001 Contingency Planning in Project Selection Using Multiobjective Optimization and Chance Constraints

Steve A. Gabriel, Javier F. Ordónez, and José A. Faria

2006 This paper presents a multiobjective optimization model for determining an efficient budget allocation for a portfolio of infrastructure projects. The model takes into account both the cost and the priority rank of each project while considering probabilistic constraints related to the available budget. A zero-one multiobjective optimization problem with chance constraints is developed and solved.

5-002 Probabilistic Segment-Linked Pavement Management Optimization Model

A. Ferreira, A. Antunes, and L. Picado-Santos

2002 An optimization model to be used within network-level PMSs is presented, together with a genetic-algorithm heuristic to solve the model. The objective of the model is to minimize the expected total discounted costs of pavement maintenance and rehabilitation actions over a given planning time span, while keeping the network within given quality standards.

5-003 Optimization of Resource Allocation and Leveling Using Genetic Algorithms

Tarek Hegazy

1999 This paper proposes resource allocation and leveling heuristics, and the genetic-algorithms (GAs) technique is used to consider both aspects simultaneously. In the improved heuristics, random priorities are introduced into selected tasks, and their impact on the schedule is monitored. The GA procedure then searches for an optimum set of tasks’ priorities with shorter project duration and better-leveled resources.

5-004 Robust Optimization of Large-Scale Systems

John M. Mulvey, Robert J. Vanderbei, and Stravros A. Zenios

1995 Mathematical programming models with noisy, erroneous, or incomplete data are common in operations research applications. In this paper they characterize the desirable properties of a solution to models, when the problem data are described by a set of scenarios for their value, instead of using point estimates. They develop a robust optimization model that explicitly incorporates the conflicting objectives of solution and model robustness.

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Table 5-1. Selected Literature in Optimization (Continued).

5-005 Linear Programming Model for Pavement Management

C. F. Davis and C. Van Dine

1988 This model uses a probabilistic linear programming formulation for optimizing maintenance and reconstruction activities. The objective function is to minimize user costs; the constraints are the budget, production capacity, and the recursive relation, which carries the optimization over the planning period.

5-006 Goal Programming and Financial Planning Models for Highway Rehabilitation

W. D. Cook 1984 This publication deals with the capital budgeting problem of highway maintenance. A two-phase approach is suggested. In phase 1 a financial planning model is used to determine appropriate budget levels. In phase 2 a goal programming model for achieving desired levels of service is given.

5-007 Multiattribute Decision Making by Sequential Resource Allocation

Peter A. Morris and Shmuel S. Oren

1980 This paper proposes an approach for addressing decision problems in which the outcomes are multidimensional and possibly interdependent. The method is based on decomposing the problem into a sequence of simpler decision problems. The solution to each subproblem is elicited from the decision maker by converting it to a simple resource allocation task that may be solved by inspection. The approach is illustrated in the context of a financial planning problem.

5-008 Optimal Resource Allocation for the Purchase of New Buses and the Rebuilding of Existing Buses as a Part of a Transit Asset Management Strategy for State DOTs

Snehamay Khasnabis, Joseph Bartus, and Richard Darin Ellis

2003 The authors present an asset management strategy that allocates capital dollars for the dual purpose of purchasing new buses and rebuilding existing buses within the constraints of a fixed budget, and distributes funds among the agencies in an equitable manner. The proposed procedure includes two optimization models. Model 1 attempts to maximize the weighted fleet life of all the buses. Model 2 is to maximize the remaining life (RL) of the entire peer group of buses.

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In order to ascertain a realistic and sufficient mathematical model for the decision of

when to purchase right-of-way within the project development process at the district level and

the partitioning of funds for both existing projects and right-of-way for the districts at the

division level, the research team will have to have access to a plethora of relevant data. This

section details some of the specified data required and the mathematical methods used to analyze

the data. Since the research team is looking at the resource allocation problem for TxDOT from

both a district and division perspective, this is reflected in the following subsections.

District-Level Data

The following paragraphs detail the necessary and sufficient data needed to utilize

optimization techniques for districts to determine the distribution of funds between existing

projects and right-of-way. Since a number of factors (mentioned later) have a bigger influence

5-009 Optimal Fund-Allocation Analysis for Multidistrict Highway Agencies

Weng Tat Chan, T. F. Fwa, and J. Y. Tan

2003 This paper employs the genetic-algorithm optimization technique to allocate the total funds available to the district or regional agencies in order to best achieve specified central and regional agencies’ goals subject to operational and resource constraints. The fund allocation problem considers the overall objective of the central agency together with a goal specified by each district or regional agency.

5-010 Multi-period Optimization of PMS

Jaewook Yoo

2004 A multi-dimensional zero-one knapsack model is formulated to schedule timely and cost-effective maintenance, rehabilitation, and reconstruction activities for each pavement section in a highway network and allocate the funding levels through a finite multiperiod horizon within the constraints of budget, activity frequency, and pavement quality. Dynamic programming and the branch-and-bound method are combined as a hybrid algorithm to solve the problem.

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on the optimization model at this particular level, we will examine these factors and possibly

incorporate them into the optimization model using regression analysis.

First, the research team will need access to historical right-of-way purchases (county,

city, and state purchases) of a timeframe of about the last 10 years in addition to the appraised

values of the land at the time of the acquisition. This information on purchase should be readily

available from TxDOT, while the property value information can be obtained from the historical

records of the Texas State Comptroller’s Office. It would also be interesting to know this

information in the context of when the right-of-ways were purchased in relation to the project

development process. This valuable information will give the research team enough historical

perspective of right-of-way purchase as well as examine the historical difference between actual

appraisal value and purchased amount.

Further, the aforementioned information is not inclusive of other expenses involved in

right-of-way acquisition, which include, but are not limited to, inflation rates and legal costs

(eminent domain versus non-eminent domain).

Siethoff et al. (2002) examined commercial property responses to a major highway

expansion in Austin, Texas, by analyzing parcel-level real estate assessment data over an 18-year

period. To illustrate the data used in the study of Siethoff et al. (2002), Figure 5-1 plots average

assessed land values per acre for each year in the study period (1982–1999).

This figure clearly shows that property assessments significantly increased in 1986, when

TxDOT began to acquire the additional right-of-way needed for the expanded facility. Property

values declined for several years after the right-of-way acquisition, remained flat during the mid-

1990s, and then increased again. The authors suggest that the observed variation in the land

value can be partially explained by the general trends in Austin’s land market during the study

period, which included a speculative bubble in the early 1980s. However, the empirical results of

their study suggested that the following factors also play key roles in property valuation:

• parcel acreages;

• improvement type and size;

• freeway proximity;

• parcel location at key network points (e.g., corner parcels); and

• timing of construction and completion.

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Figure 5-1. Average Assessed Land Values (in Dollars per Acre) in the Study by Siethoff (2000).

Based on the results of this study, we can conclude that a right-of-way acquisition and the

consequent construction project may have a considerable impact on land value in surrounding

areas, thus impacting the costs of future right-of-way acquisitions in these areas. Therefore, the

sequence in which the right-of-way acquisition and related construction projects occur in nearby

areas is a crucial consideration, which has been ignored in previous research. This issue can be

addressed by the mathematical programming models proposed in the next section.

Division-Level Data

The amount of needed data for the division-level optimization models and the difficulty

of achieving that data are far less than in the previous district-level case. Most of the information

is readily available and is currently used for the selection of projects anyway (TxDOT 2006d).

The following criteria could be used as a weighted average for producing objective coefficients

for variables related to existing projects and right-of-ways:

1. total vehicle miles traveled,

2. population,

3. lane miles,

Right-of-Way Acquired

100000 150000 200000 250000 300000 350000 400000 450000 500000

1982 1984 1986 1988 1990 1992 1994 1996 1998

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4. truck vehicle miles traveled,

5. percentage of population below the federal poverty level,

6. fatal and incapacitating crashes, and

7. past success of existing projects and right-of-ways.

Note that an incapacitating crash is one with severe injuries that would prevent the

injured from a continuation of normal activities. In addition, criteria 1 to 6 are currently utilized

by TxDOT to select projects under category 2, metropolitan area corridor projects, and

category 3, urban area corridor projects, while criterion 7 is a new proposed measure to be

implemented in selecting projects. Also, there are numerous ways to measure criterion 7. One

way is the historical difference between actual appraised value of land parcels and purchased

amounts for the right-of-way case for each district. This historical perspective can be viewed

from a 1-year, 5-year, or 10-year period. A similar measure for the existing projects would be

the historical difference between proposed budgeted value and actual cost of past projects. With

criterion 7, TxDOT can incorporate a weighting favorable to districts who historically utilized

budgeted money more effectively. Also, the aforementioned seven criteria can be modified to

conform to other goals and objectives of TxDOT through engagement from TxDOT personnel.


This section discusses several mathematical programming approaches that can be used to

determine optimal strategies for right-of-way acquisition. The particular approaches discussed

include mixed integer linear programming (MILP), mixed integer nonlinear programming

(MINLP), and stochastic dynamic programming (SDP). Each of the proposed methods has its

own advantages and disadvantages as a modeling tool and in terms of computational tractability,

and in general the choice of a method depends on the nature and scale of data available for a

particular problem.

We will use mathematical programming models to allocate a limited budget between

districts at the division level, and to allocate the funds assigned to a given district between the

projects of interest for this district. We will consider at least two alternative approaches for this

1. Top-to-bottom approach: (a) First use a division-level model to allocate the available

resources between the districts. (b) For each district, given the district’s budget found in

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step a, use a district-level model to allocate it between the projects of interest for the

2. Bottom-to-top approach: (a) Use a district-level model for the whole division to

determine the allocation between the projects of interest within the division. (b) Allocate

the funds between districts according to the budgets required to complete the projects

included in the solution obtained in step a. In order to balance the distribution of funds

between the districts, the upper and lower bounds on the percentage of the division

budget allocated to each district may be included in the model.

The top-to-bottom approach involves two conceptually different models for allocating

funds at division and district levels, while the bottom-to-top approach uses the same model at

both levels. The main advantage of the first approach is that allocation of funds between the

districts results in smaller-scale optimization problems that need to be solved for each district.

This approach is also closer to the mode in which TxDOT currently operates. On the other hand,

the bottom-to-top approach is expected to result in one very large-scale optimization problem,

instead of a number of smaller ones, since the model would incorporate detailed information

about each project considered for funding in the division. While this approach is “more fair” in

the sense that it treats all projects within the division as equal, the large scale of the resulting

model may be too difficult to overcome because exact methods and heuristic approaches would

need to be used to find suboptimal solutions. Another potential disadvantage of the second

approach is the possibility that the (sub)optimal solution may suggest a very non-uniform

allocation of funds between districts. We still believe that the bottom-to-top approach should also

be considered, and the obtained results could be used to validate the results of the top-to-bottom

The next two subsections provide more detail on district-level and division-level models

for right-of-way acquisition.

District-Level Models

The district-level models deal with allocation of a given budget among a set of right-of-

way projects of interest. These models will be used in both top-to-bottom and bottom-to-top

approaches outlined above. In order to apply these models, we will need detailed data concerning

the factors that play key roles in property valuation for all potential right-of-way sites, as

described in the “Data Collection and Processing” section. Note that the proposed mathematical

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programming models are quite flexible and can be used not only for determining an optimal

allocation of a given budget but also for estimating the right-of-way budget needs over a given

time horizon.

For example, consider a simple integer nonlinear model for the following hypothetical

situation. Assume that there are two nearby right-of-way sites to be purchased and there is a

construction project planned for each site. The plan is to complete both construction projects

within the next T years. Denote by C1t and C2t the estimated cost of site 1 and 2, respectively,

which have been computed independently for the two sites using estimation methods described

in the “Data Collection and Processing” section. We will call these values base prices. However,

as it was illustrated in the previous section, the acquisition of right-of-way and construction

development on one of the sites will impact the price of the other site. This impact can be

expressed numerically using the techniques described in the “Mathematical Programming

Models” section. Denote by Cijtrp the additional cost (may be positive or negative) of site i at

time t resulting from acquiring right-of-way on site j at year r and starting the construction on

site j at year p, where i,j=1,2; t=1,…,T; r=1,…,t; p=r,…,T. For simplicity, we assume that it

takes a constant time to complete the project, so no index representing the completion time is

needed. Denote by Xit and Yit the binary variables associated with the decision to purchase right-

of-way on site i at time t and to start the construction project on site i at time t, respectively. In

other words, Xit=1 if the right-of-way on site i is purchased at time t and Xit=0 otherwise.

Similarly, Yit=1 if the construction on site i starts at time t and Yit=0 otherwise. Then the total

additional price Cijt of site i at time t resulting from the impact of site j can be expressed as

Cijt= ∑(r=1..t)∑(p=r..T)Cijtrp XjrYjp.

If we denote by P1t and P2t the estimated cost of completing the planned construction on sites 1

and 2, respectively, assuming that the construction is started at time t, then the objective of

minimizing the total cost of right-of-way acquisition and construction completion can be written

Minimize ∑(t=1..T)((C1t +C12t) X1t + (C2t +C21t) X2t+P1t Y1t + P2t Y2t).

The requirements that the right-of-way must be purchased exactly once for each site are given by

∑(t=1..T)X1t =1 and ∑(t=1..T)Y1t =1,

∑(t=1..T)X2t =1 and ∑(t=1..T)Y2t =1,

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while the requirement that the right-of-way must be purchased before the construction begins can

be expressed by the following constraints:

Y1t ≤ 1+ ∑(u=1..t)X1u - ∑(u=t+1..T)X1u and Y2t ≤ 1+ ∑(u=1..t)X2u - ∑(u=t+1..T)X2u.

Finally, all decision variables are binary:

X1t, Y1t, X2t,Y2t are in {0,1}.

Note that Cijt is a nonlinear function of the decision variables; therefore, the above model is an

integer nonlinear program. However, the objective function of this program can be linearized to

yield an integer linear program, which can be solved to optimality using state-of-the-art

optimization software packages, such as CPLEX from ILOG or XPRESS from Dash

Optimization. However, due to the well-documented computational intractability of integer

programming, it is not realistic to expect to find an optimal solution for large-scale problems,

such as the ones that will most likely arise in a bottom-to-top approach, where the division is

treated as a district. Heuristic or metaheuristic approaches mentioned in the “Introduction”

section can be used to find a nearly optimal solution in these cases.

Note that the mathematical program described above can be easily modified to model a

practically more common situation when the budget estimates are known in advance and one is

looking for an optimal allocation of the funds available. Indeed, in this case we would need to

change the equality constraints above to ≤ constraints to reflect the fact that not all projects of

interest may be completed as planned due to budget limitations. In addition, the linear budget

constraints limiting the costs encountered each year would need to be included in the model.

Division-Level Models

The mathematical programming models for the division level are not as complicated as

the models for the district level because the number of variables in the models is limited

(25 districts). Hence, depending on the objective function derived from the seven criteria

mentioned previously, the resulting model(s) will be a linear programming (LP), nonlinear

programming (NLP), or a stochastic dynamic programming (SDP) model. LP is easy to solve but

provides only a very rough approximation of the problem of interest, while NLP and SDP

models better describe the problem but are much more involved computationally. These models

will be based upon the variables corresponding to the districts and the type of funding (right-of-

way or existing projects), and there will be real variables relating to the amount of percentage of

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the budget for the district and the type of funding (i.e., x1R = 0.85 means that 85 percent of the

budget for right-of-way will go to district one). In addition, an accurate division-level model(s)

will result from close interaction with division-level personnel to incorporate intricacies that are

not always detailed in guideline documents such as the minimum or maximum percentage of

allocated money per district. The research team can also use the SMP (TxDOT 2006d) for a

tentative guideline for these percentages. The models will incorporate making budget decisions

for a fixed number of years instead of just one year and often result in knapsack-type problems,

which can be effectively solved using dynamic programming (DP). Hence, we feel strongly that

these models for the decision at the division level can be solved to optimality a bit more easily

than at the district level. The true complexity of solving these models at the division level will

lie in the techniques to derive meaningful objective functions based upon the aforementioned

seven criteria from the “Division-Level Data” section.


The approaches proposed in this chapter allow formulating the resource allocation

problems of interest as mathematical programs, which can be solved, exactly or approximately,

using commercial or specially developed optimization software packages. The generated

solutions will help TxDOT in making decisions concerning right-of-way acquisitions in the

following ways:

• Given the planning time horizon and the right-of-way sites to be acquired, the solution

will prescribe the optimal time for right-of-way acquisition and the beginning of

construction. This information can be used to estimate the right-of-way budget needs at

the district level and to allocate funds among districts at the division level.

• If estimates of the district’s right-of-way budget are given (or computed using step a in

the top-to-bottom approach), then the proposed district-level models can be used to

optimally allocate the available budget among specific right-of-way projects of interest.

On the other hand, the provided optimal or suboptimal solutions for models without

budget constraints can be used in budget planning decisions for the considered time

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• The stochastic programming approach addresses the uncertainty in real-life data and can

be used to derive the scenario-based solutions, in which at each time moment the

decisions are made based on outcomes of random factors up to the given moment.

• The proposed optimization models can be easily modified to incorporate the dynamic

nature of data. As new information regarding the sites of interest for right-of-way

becomes available, the corresponding estimates of coefficients used in the proposed

mathematical programs can be easily updated, and more realistic solutions can be found.

• The sensitivity analysis of the proposed models will be performed by varying the input

parameters and recording and analyzing the corresponding solutions obtained.

• A software package will be developed that will allow a user to input the required data and

automatically obtain a set of feasible decisions to choose from.

Some other important issues of interest which we would like to investigate (and which

may go beyond this project) include representing the transportation infrastructure of the state of

Texas as a giant dynamic network, investigating the structural properties of this network from a

graph-theoretic viewpoint, and using optimization techniques to prescribe the future changes to

this network, which would result in improvements in desirable structural properties. We believe

that this approach would be most beneficial in the long run since it would help with short-term

decisions that would bring the transportation infrastructure a step closer to the “perfect” future

network. This is in contrast to “common sense” practice, where one is interested in making

“locally optimal” decisions without considering the long-term implications. In particular, we

believe that the long-term goal considerations should be included in valuation methods used to

estimate the dollar value of a project considered for investment.

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Dr. Seth D. Guikema is the author of this chapter. Dr. Guikema explores the potential

application of decision and risk analysis techniques to address the right-of-way early acquisition

question at TxDOT. Comments from the research team management about the decision and risk

analysis approach are presented in Chapter 7: Conclusions and Recommendations.

The goal of transportation asset management is to optimize the value of a given set of

transportation assets in order to maximize the value of these assets to the public. This implies the

need for a clear, logical objective function that truly represents the values, goals, and objectives

of TxDOT managers acting on behalf of the public of Texas. Decision analysis, and in particular

utility theory, provides a rigorous basis for developing such an objective function. At the same

time, TxDOT is beginning to explore the possibility of using options to purchase right-of-way in

advance of when right-of-way would traditionally be purchased for a given project. Having a

method to screen the large number of potential parcel purchases to identify those most at risk for

price increase could help to maximize the value of advance-purchase options for TxDOT. This

chapter gives an overview of decision analysis and utility theory and proposes methods for

creating (1) a utility function that would represent TxDOT objectives as a basis for asset

management optimization and (2) a method for screening a large number of parcels along a

potential right-of-way to identify those that are most at risk for price inflation and thus may make

good targets for short-period advance purchase options.

Transportation asset management is a systematic process for managing the construction,

maintenance, operation, safety, and other aspects of elements of transportation systems

(Obermann et al. 2002). The traditional definition of transportation asset management includes a

broad set of activities from construction engineering and pavement management to managing

environmental impacts of transportation systems, and TxDOT is broadening this scope. TxDOT

is expanding transportation asset management to include right-of-way procurement. In particular,

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TxDOT is interested in using short-period options2 as a way to procure selected parcels of land

early in the project development process. While only three short-period options have been sold to

date, the intention of TxDOT is to use these options after the preliminary design phase of the

project has been completed but prior to completion of environmental clearance for the project.

This is in contrast to typical right-of-way acquisition which can begin only after the final

alignment for a roadway is selected as part of the National Environmental Policy Act (NEPA)

environmental clearance process.

The use of short-period options gives TxDOT a flexible and potentially powerful tool for

right-of-way acquisition that it otherwise would not have. Under previous federal and state law,

right-of-way could be acquired prior to the completion of the NEPA environmental clearance

process only in the case of a protective purchase, a hardship purchase, or a donation as defined

under federal and state laws and regulations (e.g., 23 CFR 710 and Section 202.112 of the Texas

Transportation Code). These special cases dealt with only a limited number of parcels and

carried stringent legal requirements limiting their use. Recent changes in the Texas