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CONTENT

TYPES OF COSTS

COST ESTIMATION MANAGEMENT

THE WHY OF COST ESTIMATION

WAYS OF COST ESTIMATION

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The why?

Project estimation is indeed a yardstick for project cost control. And if the yardstick is faulty, you start on the “wrong foot.” . . . We exhort you not to underestimate the estimate.*

* O. P. Kharbanda and J. K. Pinto, What Made Gertie Gallop: Learning from Project Failures (New York: Von Nostrand Rein- hold, 1996), p. 73.

Cost estimation is a natural first step in determining if the project will be profitable, if the company can afford the project and in general if the project is worth pursuing.

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Cost control

• Provides the company with a cost range for bidding (in the case of a customer-oriented project). • Leads to budgeting of monetary and

other resources (both material and human). These allocations must coordinate with the WBS and project schedules prepared by management to figure out if the required resources will be available as needed.

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Problems with Cost Estimation

üLow initial estimatesüUnexpected technical difficultiesüLack of definitionüSpecification changesüExternal factors

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Factors Influencing the Quality of Estimates

1. Planning Horizon2. Project Complexity3. People4. Project Structure and Organization5. Padding Estimates6. Organization Culture7. Other Factors

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Project cost estimate comparisons

Timothy, Vitall, Kathryn, 2019)

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Time and Cost Estimate Accuracy by Type of Project

(Larson & Gray, 2019)

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Bottom-up vs Top down

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Conditions for Preferring Top-Down or Bottom-Up Time and Cost Estimates

(Larson & Gray, 2019)

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A. TOP-DOWN BUDGETING

• Aggregate budgets can often be developed quite accurately• Budgets are stable as a percent of total

allocation• Small yet costly tasks do not need to be

individually identified• The experience and judgment of the

executive accounts for small but important tasks to be factored into the overall estimate

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Top-Down Approaches

I. Consensus Methods (conceptual stage)

II. Ratio Methods (parametric)

III. Apportion MethodsIV. Function Point Methods (for Software and

System Projects)

V. Learning Curves

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(I) Consensus Methods (conceptual stage)

This method simply uses the pooled experience of senior and/or middle managers to estimate the total project duration and cost.

This typically involves a meeting where experts discuss, argue, and ultimately reach a decision as to their best guess estimate. Firms seeking greater rigor will use the Delphi Method to make these macro estimates.

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(II) Ratio Methods (parametric)

• used in the concept or “need” phase of a project to get an initial duration and cost estimate for the project. • For example, contractors frequently use number of square

feet to estimate the cost and time to build a house; • that is, a house of 2,700 square feet might cost

$160 per square foot so total = $432,000(2,700 feet × $160 per foot).

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(III) Example:Apportion Method of Allocating Project Costs

5-1

(Larson & Gray, 2019)

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(III) Example: Simplified Basic Function Point Count Process for a Prospective Project or Deliverable

(Larson & Gray, 2019)

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Simplified Basic Function Point Count Process for a Prospective Project or Deliverable

(Larson & Gray, 2019)

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(IV) Learning Curve

• The concept behind learning curves is simple: The more times a person performs an activity, the better and faster he or she becomes

• The rate of improvement can vary widely depending on many factors, such as:

Ø How much the culture of the organization stresses continual improvement

Ø How much skill is involved in the activityØ How complex that activity isØ How much of the activity is dependent on the

worker versus dictated by the pace of a machine

Ø If there is frequent job rotation

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B. BOTTOM-UP BUDGETING

• In this method, elemental tasks, their schedules, and their individual budgets are constructed following the WBS or project action plan• The people doing the work are consulted

regarding times and budgets for the tasks to ensure the best level of accuracy• Initially, estimates are made in terms of

resources, such as labor hours and materials• Bottom-up budgets should be and usually are,

more accurate in the detailed tasks, but it is critical that all elements be included

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WBS Cost Estimate

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Bottom-Up Approaches

I. Template MethodsII. Parametric Procedures Applied to

Specific TasksIII. Range EstimatingIV.Phase Estimating

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(I) Template Method• If the project is similar to past projects, the

costs from past projects can be used as a starting point for the new project.

• Differences in the new project can be noted and past times and costs adjusted to reflect these differences.

• This approach enables the firm to develop a potential schedule, estimate costs, and develop a budget in a very short time span.

• Development of such templates in a database can quickly reduce estimate errors.

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(II) Example: Parametric Procedures Applied to Specific Tasks

• For example, as part of an MS Office conversion project:• 36 different computer workstations

needed to be converted. Based on past conversion projects, the project manager determined that on average one person could convert three workstations per day. • à the task of converting the 36

workstations would take [(36/3)/3] = 4 technicians in 3 days

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(III) Range Estimate

• Range estimating works best when work packages have significant uncertainty associated with the time or cost to complete.• Required having a group

determine the low, average, and high cost or duration gives best results.• Range estimating is popular in

software and new product projects where up-front requirements are fuzzy and not well known.

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(IV) Phase Estimate

• Some projects by their nature cannot be rigorously defined because of the uncertainty of design or the final product. • Although rare, such projects do exist. These projects are often found

in aerospace projects, IT projects, new technology projects, and construction projects where design is incomplete.• Phase estimating uses a two-estimate system over the life of the

project:• A detailed estimate is developed for the immediate phase • and a macro estimate is made for the remaining phases of the

project.

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A Hybrid: Phase Estimating

This approach begins with a top-down estimate for the project and then refines esti- mates for phases of the project as it is implemented. Some projects by their nature cannot be rigorously defined because of the uncertainty of design or the final product. Although rare, such projects do exist. These projects are often found in aerospace projects, IT projects, new technology projects, and construction projects where design is incomplete. In these projects, phase or life-cycle estimating is frequently used.

(Larson & Gray, 2019)

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SUMMARY: TOP-DOWN AND BOTTOM-UP ESTIMATES

(Larson & Gray, 2019)

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Types of Costs

1. Direct Vs. Indirect2. Fixed Vs. Variable3. Recurring Vs. Nonrecurring4. Normal Vs. Expedited

Copyright ©2016 Pearson Education, Inc.

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1. Direct vs Indirect Project Price Breakdown

Source: Used by permission of Dr. B.C. Kim

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Example: Fully Loaded Labor Costs

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2. Fixed Vs. Variable

do not vary with respect to their usage

are in direct proportion to the usage level

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3. Recurring Vs. Nonrecurring

typically continue to operate over the project’s life cycle (labor, material, logistics, sales costs…)

associated with charges applied once at the beginning or end of the project (preliminary marketing analysis, personnel training, out- placement services…)

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4. Normal Vs. Expedited

incurred in the routine process of working to complete the project per the original, planned schedule agreed

incurred when steps are taken to speed up the project’s completion.

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Time-cost Tradeoffs For Crashing Activities

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Example 1: Calculating the Cost of Crashing

suppose: • normal activity duration = 5 weeks• normal cost = $12,000• crashed activity duration = 3 weeks• crashed cost = $32,000

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Example 2: a. What is the cost per day to crash each of the activities? b. Assuming that only activities A, C, and E are part of the critical path, which

activities should be crashed first?

2000 - 1500

3 - 2= 500A =

Activity A = $500 Activity B = $1,500 Activity C = $700Activity D = $1,750 Activity E = $1,200 Activity F = $700

DAILY CRASH COST

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Cost Classifications

Direct Labor X X X XBuilding Lease X X X XExpedite X X X XMaterial X X X X

Dire

ct

InD

irect

Recu

rring

Non

-recu

rring

Fixe

d

Va

riab

le

Exp

edite

d

Nor

ma

l

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Common causes of project cost’s failures• Anywhere from about 3/5 to five-sixths of projects fail to meet their

time, cost, and/or specification objectives• There are several common causes:

1. Arbitrary and impossible goals2. Scope creep3. Improper risk and Uncertainty management4. Wildly optimistic estimates in order to influence the project

selection process5. Project performance failure6. Errors in project design7. Changes in resource prices8. Failure to include an allowance for waste and spoilage9. Bad luck

https://www.actitime.com/project-cost-management/causes-of-cost-overruns/

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Project Cost Management

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Resource Planning

• Part of the initiation stage of a project, resource planning uses a work breakdown structure — a hierarchical representation of all project deliverables and the work required to complete them —

à to calculate the full cost of resources needed to complete a project successfully. • Managers typically determine required resources for each work

breakdown structure component and then add them to create a total resource cost estimate for all project deliverables.

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Cost Estimating

• Cost estimating is an iterative process that uses a variety of estimating techniques to determine the total cost of completing a project.

• Cost estimating techniques vary widely in their approaches to computing project costs, and stretch from conceptual techniques that draw mainly from historical experience and expert judgment to determinative techniques that estimate costs on a component-by-component basis.

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Cost Budgeting

• Once you’ve created satisfactory estimates, we can finalize and approve the project’s budget. • Cost managers typically release budgeted amounts in stages

according to the level of a project’s progress. • These allocations include contingencies and reserves.

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Improving the Process of Cost Estimation

• There are two fundamentally different ways to manage the risks associated with the chance events that occur on every project:• The most common is to make an allowance for

contingencies - usually 5 or 10 percent• Another is when the forecaster selects “most likely,

optimistic, and pessimistic” estimates

Via Bidding

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Budget Contingencies

The allocation of extra funds to cover uncertainties and improve the chance of

finishing on time.

Contingencies are needed because• Project scope may change• Murphy’s Law is present• Cost estimation must anticipate interaction costs• Normal conditions are rarely encountered

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Reserve Analysis

• Reserves & risk management are important while estimating!– Contingency reserves: à Cost

Baseline the cost impacts of the remaining risk

– Management reserves: à Cost Budgetextra fund to cover unforeseen risk or changes to the project Activity estimates

Work package estimates

Control account estimates

Project estimates

Contingency reserves

Management reserves

Cost baseline

Cost budget

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Cost Control

• Cost control is the practice of measuring a project’s cost performance according to cost and schedule baselines that provide points of comparison throughout the project life cycle. • The specific requirements for effective cost control are set out in the

project management plan. The individual in charge of cost management investigates the reasons for cost variations - if they deem cost variations unacceptable, corrective action is likely. • Cost control also includes other related responsibilities, such as

ensuring that updated project budgets reflect changes to a project’s scope.