Estimate Project Cost

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Cost Estimating

Cost estimating is the process of determining the likely cost of performing a defined scope

of work at a future time. As with any attempt to predict the future, it is unreasonable to

expect a cost estimate to be 100 percent correct. The estimating process should be

focused on determining a reasonably accurate estimate based on defined assumptions for

a reasonable expenditure of effort. The estimate should be supported by appropriate risk

management strategies and management reserves based on an appreciation of the likely

levels of variability and uncertainty inherent in the estimate.

The core stages in developing a pragmatic and reasonable process for cost estimating are

as follows:

Plan the estimating strategy based on available estimating resources and available

budget for preparing the estimate.

Determine the most appropriate approaches to develop the estimate. Select the

most appropriate methodology consistent with the organization's culture and

objectives.

Consider any estimating inputs to the project delivery strategy, such as assessing the

cost effectiveness of alternative methodologies and strategies.

Develop systems to ensure the estimate covers 100 percent of the scope (this is

nearly impossible, but essential). In particular ensure potential future suppliers and

subcontractors have included within their submitted price all of the scope of work

you expect them to price.

Determine the appropriate estimating technique to use. In most projects, a

combination of these options are used to obtain the best estimate:

analogous—comparing the current project with a similar completed project and

making appropriate adjustments. This is relatively quick but requires expert

knowledge. It is generally seen as the least accurate approach and this depends

on the degree of knowledge and expertise. In most situations the degree of

accuracy associated with an analogous estimate is considered to be a rough

Learning Resource

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order of magnitude (ROM) estimate, with a range of -25 percent to +75

percent.

parametric—using adjusted historical data to price defined elements of the

project such as the cost per function point in software development and the

cost per square (10 square miles) in domestic construction work.

bottom-up (or detailed) estimating—the cost of each resource used in the

project is determined and multiplied by the quantity required. This is the most

expensive estimating process and the most accurate. A detained engineering

estimate can be as accurate as -5 percent to +15 percent.

vendor bid analysis—where prices for different components of the project are

obtained from the market and compiled to generate the cost of the overall

project.

Consider a staged approach to estimating, if possible. Near-term work can be

estimated more accurately then far-term, but many projects need an overall

estimate. Approaches such as rolling wave can be very useful.

Determine the allocation of organizational overheads to the project costs and how

these will be applied.

Determine which costs are fixed (occurring only once regardless of the actual project

outcomes) and which are variable (change in relation to changes in the project's work

or time). Generally, small savings or errors on variable costs that occur every week

will add up to a lot more than a larger one-off saving (or error) on a fixed cost. Focus

most effort onto the costs that have the biggest effect overall.

Develop or adjust estimating rates for work to be priced internally. These rates

should account for the following:

loaded hourly cost rates

loaded cost per unit or element (parametric estimates)

balancing the allocation of costs between project overheads and loaded cost

rates

Assess the likely levels of estimating error to develop contingencies and reserves,

accounting for the following:

variability in estimated costs and rates (there will always be a level of

variability)

estimating errors (e.g., omissions and duplications)

external events and changes in the market (e.g., suppliers ceasing to trade)

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assess future cost movements (e.g., inflation)

Understand the intensity of the work. Costs are minimized if the optimum crew sizes

are applied to the work and it takes a normal time to complete. High intensity work

associated with a crashed schedule generally causes increased inefficiencies and

drives up costs.

Identify estimating and other risks and link to the project's risk management

processes. The way the estimate has been developed is itself a risk issue, plus there

will be identified risks arising from interaction with suppliers, contractors, and

others.

Link estimating to procurement to minimize risk exposure from suppliers and

subcontractors.

Once the estimating process is properly planned, the actual work of developing the

estimate can be undertaken with the final output the expected cost of the work and a

recommended level of management reserves. The US Government Accountability Office

has developed a comprehensive guide to developing credible cost estimates and then

managing the budget for a project using earned value. The GAO "Cost Estimating and

Assessment Guide" is particularly useful for major projects.

Cost Estimating versus Pricing

The cost estimate is the net cost of completing the scope of work. The price charged to a

client for the work should consist of the following elements:

estimated cost

reasonable level of management reserves (contingency) to cover both the expected

level of variability in the cost price and an allowance for identified risk events

amount of profit to reward the organization for the risks involved in undertaking the

work and to compensate for the use of the organization's capital to undertake the

work. This would normally exceed the amount received from a safe investment (e.g.,

a bank deposit).

The final price is always a subjective management decision based on the defined items

above, an assessment of the market and what is likely to be an acceptable price, and views

on the level of competition from others, combined with the organization's level of desire

to win the work.

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The above factors are focused on a competitive estimate to win work by a commercial bid

or tender. If the work is internal to the organization, the expected benefits to be realised

define an acceptable price.

Cost Estimating & Risk Minimization

Estimating what something will cost in the future is a risk. It is impossible to forecast what

the element of work will actually cost. The estimating processes need to balance the

mutually exclusive options of seeking the lowest practical cost estimate and minimizing

risk. Risk is reduced if the estimated values are inflated but the unnecessarily high cost

estimates tend to make competitive bids too expensive to win work and internal projects

too expensive to undertake. Decision need to be made to balance cost and risk within the

risk tolerance levels of the organization's management. Some of the decisions that need to

be made include the following:

In-house resources or subcontract?

Direct in-house resources are subject to more control, direction, and

motivation, but any estimating errors in the quantum of effort needed to

accomplish the work are a direct cost to the project (as are supervision, quality

defects, etc.).

Subcontractors can be expected to carry the consequences of their estimating

errors and perform the work for the agreed price. However, there is a loss of

direct control and the need to manage contracts. At least some of the risk is

transferred to the subcontractor.

Low price or safe suppliers and subcontractors?

Low bids from suppliers and subcontractors allow the overall estimate to be

lower, increasing your competitive advantage. The low bid may be due to a

competitive advantage held by the supplier or subcontractor.

The low bid contractor may have made an error in its estimating processes. In

this circumstance the contractor may refuse to take on the work or chose to

take on the work with the intention of making claims to recover its loss or

delivering a lower-quality product.

Firm fixed price or cost reimbursable contacts?

A fixed price offers no insight into the way the contractor calculated its bid and

tends to make the price changes expensive (there is no base for comparison).

Cost reimbursable contracts allow insight into the pricing process but require

additional estimating to determine the cost.

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The combination of options that provides the best (lowest) cost outcome within an

acceptable risk parameter requires careful judgement within the organization's overall

governance processes.

Major contractors divide the work between suppliers and subcontractors (i.e., their supply

chain). The art of managing the estimating process is to ensure all of the work is portioned

out to trade packages and there are no duplications. The art of estimating is to ensure 100

percent of the work is priced—but only once! In addition, the accepted prices used in the

estimate have been risk assessed on the likelihood of the quoted price being achieved by

the supplier.

Appropriate Levels of Detail

Adding detail to an estimate will not automatically improve accuracy. Accuracy is only

improved if improved knowledge or insight is achieved. Processes such as estimating the

cost of individual efforts against work on scheduled activities can only add value if the

information being used is based on new and enhanced information, preferably gathered

from the person actually involved in the work (or from knowledge of the specific person).

This type of estimating is appropriate for short-term work, but is pointless for tasks

scheduled months in the future, where the precise scope of work is not known, and the

people who will be doing the work are not defined.

Adding unnecessary detail increases costs, increases the workload, reduces visibility, and

reduces flexibility. Superficial detail will also change expectations of more senior

managers, who may believe the information is valid and therefore believe it is safe to

reduce contingencies.

Guideline for Creating a Good Estimate

Estimators forecast the future, attempting to predict the time and money required to

produce a product or service. Predicting the future is never an easy task, and it becomes

increasingly difficult the more unique the project. However, knowing and applying the

golden rules of estimating, listed below will provide greater opportunity for a successful

forecast.

Find the Right Estimator

Estimators familiar with the work and estimating methods are key. There are many

estimating techniques, including phased, top-down, analogous, parametric, and bottom-

up. Regardless of the estimating method, the person making the estimate should have an

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understanding of the work to be done, and of the techniques and goals of estimating. He

or she needs to understand that the goal is to predict the most likely outcome.

Estimate Based on Experience

All projects are unique, but they often have similarities with other historical projects. Data

from past projects can be helpful in estimating future ones—past performance data

improves the accuracy of any of the discussed estimating techniques. Formal data is best,

but if it is unavailable, people's personal experiences and recollections are valid, but need

confirmation.

Avoid Negotiating Estimates

Though the tendency of management is to request estimate changes to reduce time and

cost, this move should be resisted by demonstrating that the estimate was created from

project specifications and represents a realistic balance of cost, schedule, and risk. Also,

demonstrate that the estimate is linked to product specifications and the work breakdown

structure. Further, highlight that the only way to reduce an accurate estimate is by

changing the product scope or worker productivity.

Linking Cost Estimates with the Schedule

Apart from very small short-term projects (three to six months and under $200,000),

attempting to directly integrate the cost estimating process with the scheduling process is

fraught with difficulty. Even on these smaller projects, direct linking is not really feasible

unless the primary source of all costs is staff directly employed on the work.

Most normal projects require a degree of integration between cost and schedule. This is

usually achieved by developing a WBS and integrating time, cost, scope, risk, and quality

at either the work-package level or the control-account level.

Dealing with Objections

It is not uncommon in internal projects and negotiations, that your carefully prepared

project estimates have to be justified or defended if the client or sponsor thinks the

numbers are too high. If you have done the estimating properly, reducing the price or time

in the face of an objection simply creates a bigger problem later when the project

overruns its reduced costs or time.

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Information is the key to validating your work. You should be able to defend the estimate

by demonstrating the following components:

your understanding of the work

estimating techniques you used

estimate of the effort hours, duration, and cost

detailed estimating information in case the sponsor would like to review

estimating assumptions

level of uncertainty as reflected in the estimating range

This level of information gives you the facts to respond to the challenge, and it will stop

many challenges because people will have difficulty disputing your facts. The keys to this

part of discussion are your credibility and the quality of the information you have

presented.

Once the credibility of your estimate is accepted based on your estimating rigor, the

discussion can then proceed to alternatives. If the sponsor still thinks the numbers are too

high, or cannot afford the solution at that cost, there are a few alternative options:

Determine if the client has any additional information that would allow you to revise

your assumptions and perhaps revise the estimate. For instance, if a critical end date

now has some flexibility, perhaps the estimate can be revised based on this new

information.

Determine whether high-level requirements and functionality can be scaled back. In

many cases, the original set of features and functions is more of a wish list. After

seeing a price tag, it is very possible that the client can live without certain features.

If you included a high contingency to reflect a high estimating risk, ask the client for

more time to gather more detail for the estimate, which may result in less

uncertainty and risk and allow you to reflect this as a smaller contingency.

No estimate is perfect. Sensible sponsors and clients are seeking reassurance that you

have done the best job possible in the circumstances, and the costs are realistic. This

reassurance requires that they believe you are skilled and credible and your estimating

processes were rigorous and effective.

Managing the Estimate—Lessons Learned

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Estimating normally precedes the start of a project, or is completed in the early concept

and planning phases. While the estimate may go through several iterations as its final

scope is firmed up, the normal expectation is the estimate should be converted to the cost

baseline before the main execution phase begins.

The cost baseline provides one of the key foundations for the ongoing management of the

project work. The cause of any variance from the baseline should be identified, and

options developed to lock in gains and mitigate losses. This is the domain of project

controls, cost engineering, earned value management, and project administration.

Estimating processes are used for price variations and occasionally to re-estimate the

project if the original cost baseline is found to be invalid. However, numerous surveys

have shown that in most circumstances, re-estimating the project costs is less accurate

then applying earned value calculations. The exception is where major changes in the

structure of the project team or management have occurred.

Upon the completion of the project, and occasionally during the execution of the project,

it is important to undertake an effective "lessons learned" study to determine the voracity

of the estimating process and identify areas for improvement. A major advantage of

retained organizational experience is the capability to accurately price work in a particular

domain and understand and manage the associated risks.

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