Project Cost Management

The Importance of Project Cost

Management
• IT projects have a poor track record for
meeting budget goals
• The CHAOS studies found the average cost
overrun ranged from 180 percent in 1994 to
43 percent in 2002; other studies found
overruns to be 33-34 percent

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 What is Cost and
Project Cost Management?
• Cost is a resource sacrificed or foregone to achieve a
specific objective or something given up in exchange
– Costs are usually measured in monetary units like dollars
or Rs.
• Project cost management includes the processes
required to ensure that the project is completed
within an approved budget
– Project managers must make sure their projects are well
defined, have accurate time and cost estimates and have
a realistic budget that they were involved in approving

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 Reasons for Cost Overruns
• Not emphasizing the importance of realistic project
cost estimates from the outset
– Many of the original cost estimates for IT projects are low to
begin with and based on very unclear project requirements
• Many IT professionals think preparing cost estimates is
a job for accountants when in fact it is a very
demanding and important skill that project managers
need to acquire
• Many IT projects involve new technology or business
processes which involve untested products and
inherent risks
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Project Cost Management Processes
• There are three project cost management
processes:
– Cost estimating: developing an approximation or
estimate of the costs of the resources needed to
complete a project
– Cost budgeting: allocating the overall cost estimate
to individual work items to establish a baseline for
measuring performance
– Cost control: controlling changes to the project
budget

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 Cost of Software Defects

It is much more cost-effective to spend money on defining

user requirements and doing early testing on IT projects than
to wait for problems to appear after implementation
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Basic Principles of Cost Management
– Cash flow analysis determines the estimated annual costs
and benefits for a project and the resulting annual cash
flow
• Too many projects with high cash flow needs in the same year
may not be able to be supported which will impact profitability

• Tangible costs or benefits are those costs or benefits that an

organization can easily measure in dollars or Rs.

• Intangible costs or benefits are costs or benefits that are

difficult to measure in monetary terms
– Costs – resources used to research related areas of a project
but not billed to the project
– Benefits – goodwill, prestige, general statements of improved
productivity not easily translated in dollars
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Basic Principles of Cost Management
• Direct costs are costs that can be directly related to
producing the products and services of the project
– Salaries, cost of hardware and software purchased
specifically for the project
• Indirect costs are costs that are not directly related to the
products or services of the project, but are indirectly
related to performing the project
– Cost of electricity, paper towels
• Sunk cost is money that has been spent in the past; when
deciding what projects to invest in or continue, you
should not include sunk costs
– To continue funding a failed project because a great deal of
money has already been spent on it is not a valid way to
decide on which projects to fund
– Sunk costs should be forgotten
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Basic Principles of Cost Management
• Learning curve theory states that when many items are
produced (or tasks are performed) repetitively, the unit
cost of those items decreases in a regular pattern as more
units are produced (or more tasks performed)
• Reserves are dollars included in a cost estimate to mitigate
cost risk by allowing for future situations that are difficult
to predict
– Contingency reserves allow for future situations that may be
partially planned for (sometimes called known unknowns)
and are included in the project cost baseline
• Recruiting and training costs for expected personnel turnover
during a project
– Management reserves allow for future situations that are
unpredictable (sometimes called unknown unknowns)
• Extended absence of a manager; supplier goes out of business

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 Cost Estimating
• After developing a good resource requirements
list, PMs and their teams must develop several
estimates of the costs for these resources
• Project managers must take cost estimates
seriously if they want to complete projects
within budget constraints
• It’s important to know the types of cost
estimates, how to prepare cost estimates, and
typical problems associated with IT cost
estimates
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 Cost Estimating
• A rough order of magnitude (ROM) estimate
provides an estimate of what a project will cost.
– Also referred to as a ballpark estimate, a
guesstimate.
– Done very early in a project, or even before a
project is officially started to help PMs make
project selection decisions.
– Accuracy is typically -50 percent to +100
percent, meaning the project’s actual costs
could be 50 percent below the ROM estimate or
100 percent above. 11
 Cost Estimating
• A budgetary estimate is used to allocate
money into an organization’s budget.
– Many organizations develop budgets at least
two years into the future.
• Budgetary estimates are made one to two years
prior to project completion.
– The accuracy of budgetary estimates is
typically -10% to +25%

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 Cost Budgeting
• Cost budgeting involves allocating the project cost
estimate to individual work items over time
• The WBS is a required input to the cost budgeting
process since it defines the work items
• An important goal is to produce a cost baseline
– A time-phased budget that project managers use to
measure and monitor cost performance
– Estimating costs for each major project activity over
time provides management with a foundation for
project cost control
– Cost budgeting also provides info for project funding
requirements –at what point(s) in time will the money
be needed
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 Cost Estimating
• A definitive estimate provides an accurate estimate of
project costs (most accurate of the three types).
– Definitive estimates are used for making many purchasing
decisions for which accurate estimates are required and for
estimating final project costs.
– For example, if a project involves purchasing 1000 personal
computers from an outside supplier in the next three
months, a definitive estimate would be required to aid in
evaluating supplier proposals and allocating the funds to pay
the chosen supplier.
– Definitive estimates are made one year or less prior to
project completion
– Accuracy range is normally -5% to +10%
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 Cost Management Plan
• A cost management plan is a document
that describes how the organization will
manage cost variance on the project
– For example, how to respond to proposals
from suppliers that are higher or lower than
estimates
– A large percentage of total project costs are
often labor costs, so project managers must
develop and track estimates for labor

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 Cost Estimation Tools and Techniques
• Analogous or top-down estimates: use the actual
cost of a previous, similar project as the basis for
estimating the cost of the current project
– How similar the current and previous project are
determines the accuracy of the estimate.
• Bottom-up estimates or Activity Based Costing :
involve estimating individual work items or
activities and summing them to get a project total
– The smaller the work items, the better the estimate
but these estimates are usually time intensive and
expensive to develop 16
 Cost Estimation Tools and Techniques
• Parametric modeling: uses project characteristics
(parameters) in a mathematical model to estimate
project costs
– For example, a model might provide an estimate of $50 per line
of code for a s/w development project based on the
programming language, level of expertise of the programmers,
size and complexity of the data involved, etc
– Some models may be simpler such as a $10,000 ballpark
estimate per workstation in a large office automation project
based on history of similar projects during the same time
period

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 Typical Problems with IT Cost Estimates
• Estimates are done too quickly
• Lack of estimating experience
• Human beings are biased toward underestimation
– Senior team members make estimates based
on their skill level but should take into account
the junior people on the project
• Management desires accuracy but wants to spend
less in order to win a bid or internal funding

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 Cost Control
• Project cost control includes:
– Monitoring cost performance
– Ensuring that only appropriate project changes are
included in a revised cost baseline
– Informing project stakeholders of authorized changes
to the project that will affect costs
• Many organizations around the globe have
problems with cost control

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 Cost Control
• Performance review meetings can be a powerful tool to
help control project costs

– Knowing you have to report on your progress is an

incentive for people to perform better

• Performance measurement is another important tool for

cost control
Using Software to Assist in Cost Management
• Spreadsheets are a common tool for resource
planning, cost estimating, cost budgeting, and cost
control
• Many companies use more sophisticated and
centralized financial applications software for cost
information
• Project management software has many cost-
related features, especially enterprise PM software
– Several companies have developed methods to link
data between their project management software and
their main accounting systems
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 Software Cost Estimation

• Determine size of the product.

• From the size estimate,
– determine the effort needed.
• From the effort estimate,
– determine project duration, and cost.

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Software Cost Estimation
Effort Estimation Cost
Estimation

Size Staffing
Estimation Estimation

Duration
Estimation Scheduling

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 Software Cost Estimation

• Three main approaches to

estimation:
–Empirical
–Heuristic
–Analytical

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 Software Cost Estimation Techniques

• Empirical techniques:
– an educated guess based on past experience.
• Heuristic techniques:
– assume that the characteristics to be estimated can
be expressed in terms of
some mathematical expression.
• Analytical techniques:
– derive the required results starting from certain
simple assumptions.

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Empirical Size Estimation Techniques
• Expert Judgement:
– An educated guess made by an expert
after analyzing the problem.
– Suffers from individual bias and human
error.

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 Expert judgement
• Experts divide a software product into
component units:
– e.g. GUI, database module, data
communication module, billing module, etc.
• Add up the guesses for each of the
components.

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 Delphi Estimation:
• Overcomes some of the problems of expert
judgement
• Team of Experts and a coordinator.
• Experts carry out estimation independently:
– mention the rationale behind their estimation.
– coordinator notes down any extraordinary
rationale:
• circulates among experts.

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 Delphi Estimation:

• Experts re-estimate.
• Experts never meet each other to
discuss their viewpoints.

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 Heuristic Estimation Techniques

• Single Variable Model:

– Parameter to be Estimated=C1(Estimated
Characteristic)d1
• Multivariable Model:
– Assumes that the parameter to be estimated
depends on more than one characteristic.
– Parameter to be Estimated=C1(Estimated
Characteristic)d1+ C2(Estimated Characteristic)d2+…
– Usually more accurate than single variable
models.
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