Cost Estimation and Management Strategies

Cost Estimation and Management Strategies Introduction Cost is one of the three pillars supporting project success or failure, the other two being Time and performance. Projects that go significantly over budget are often terminated without achieving the construction project goals because stakeholders simply run out of money or perceive additional expenditures as throwing good money after bad. Projects that stay within budget are the exception, not the rule. A construction project manager who can control costs while achieving performance and schedule goals should be viewed as somewhat of a hero, especially when we consider that cost, performance, and schedule are closely interrelated. The level of effort and expertise needed to perform good cost management are seldom appreciated. Too often, there is the pressure to come up with estimates within too short a period of time. When this happens, there is not enough time to gather adequate historical data, select appropriate estimating methods, consider alternatives, or carefully apply proper methods. The result is estimates that lean heavily toward guesswork. The problem is exacerbated by the fact that estimates are often not viewed as estimates but more as actual measurements made by some time traveller from the future. Estimates, once stated, have a tendency to be considered facts. Project managers must remember that estimates are the best guesses by estimators under various forms of pressure and with personal biases. They must also be aware of how others perceive these estimates. It requires an understanding of costs far beyond the concepts of money and numbers. Cost of itself can be only measured, not controlled. Costs are one-dimensional representations of three-dimensional objects travelling through a fourth dimension, time. The real-world things that cost represents are people, materials, equipment, facilities, transportation, etc. Cost is used to monitor performance or use of real things but it must be remembered that management of those real things determines cost, and not vice versa. Cost Management Cost management is the process of planning, estimating, coordination, control and reporting of all cost-related aspects from project initiation to operation and maintenance and ultimately disposal. It involves identifying all the costs associated with the investment, making informed choices about the options that will deliver best value for money and managing those costs throughout the life of the project, including disposal. Techniques such as value management help to improve value and reduce costs. Open book accounting, when shared across the whole project team, helps everyone to see the actual costs of the project. Process Description The first three cost management processes are completed, with the exception of updates, during the project planning phase. The final process, controlling costs, is ongoing throughout the remainder of the project. Each of these processes is summarized below. Resource Planning Cost management is begun by planning the resources that will be used to execute the project. Figure 6-2 shows the inputs, tools, and product of this process. All the tasks needed to achieve the project goals are identified by analyzing the deliverables described in the Work Breakdown Structure (WBS). The planners use this along with historical information from previous similar projects, available resources, and activity duration estimates to develop resource requirements. It is important to get experienced people involved with this activity, as noted by the expert judgment listed under Tools. They will know what works and what doesnt work. In trying to match up resources with tasks and keep costs in line, the planners will need to look at alternatives in timing and choosing resources. They will need to refer back to project scope and organizational policies to ensure plans meet with these two guidelines. Except for very small projects, trying to plan without good project management software is tedious and subject to errors, both in forgetting to cover all tasks and in resource and cost calculations. The output of this process is a description of the resources needed, when they are needed, and for how long. This will include all types of resources, people, facilities, equipment, and materials. Once there is a resource plan, the process of estimating begins. Estimating Costs Estimating is the process of determining the expected costs of the project. It is a broad science with many branches and several popular, and sometimes disparate, methods. There are overall strategies to determining the cost of the overall project, as well as individual methods of estimating costs of specific types of activity. Several of these can be found in the resources listed at the end of the chapter. In most software development projects the majority of the cost pertains to staffing. In this case, knowledge of the pay rates (including overhead) of the people working on the project, and being able to accurately estimate the number of people needed and the time necessary to complete their work will produce a fairly accurate project cost estimate. Unfortunately, this is not as simple as it sounds. Most project estimates are derived by summing the estimates for individual project elements. Several general approaches to estimating costs for project elements are presented here. [3] Your choice of approach will depend on the time, resources, and historical project data available to you. The cost estimating process elements are shown in Figure. Figure 6-3 Cost Estimating Elements Cost estimating uses the resource requirements, resource cost rates, and the activity duration estimates to calculate cost estimates for each activity. Estimating publications, historical information, and risk information are used to help determine which strategies and methods would yield the most accurate estimates. A chart of accounts may be needed to assign costs to different accounting categories. A final, but very important, input to the estimating process is the WBS. Carefully comparing activity estimates to the activities listed in the WBS will serve as a reality check and discover tasks that may have been overlooked or forgotten. The tools used to perform the actual estimating can be one or more of several types. The major estimating approaches shown in Figure 6-3 are discussed here. While other approaches are used, they can usually be classed as variations of these. One caution that applies to all estimating approaches: If the assumptions used in developing the estimates are not correct, any conclusions based on the assumptions will not be correct either. Bottom-Up Estimating Bottom-up estimating consists of examining each individual work package or activity and estimating its costs for labour, materials, facilities, equipment, etc. This method is usually time consuming and laborious but usually results in accurate estimates if well prepared, detailed input documents are used. Analogous Estimating Analogous estimating, also known as top-down estimating, uses historical cost data from a similar project or activities to estimate the overall project cost. It is often used where information about the project is limited, especially in the early phases. Analogous estimating is less costly than other methods but it requires expert judgment and true similarity between the current and previous projects to obtain acceptable accuracy. Parametric Estimating Parametric estimating uses mathematical models, rules of thumb, or Cost Estimating Relationships (CERs) to estimate project element costs. CERs are relationships between cost and measurements of work, such as the cost per line of code. [3] Parametric estimating is usually faster and easier to perform than bottom-up methods but it is only accurate if the correct model or CER is used in the appropriate manner. Design-to-Cost Estimating Design-to-cost methods are based on cost unit goals as an input to the estimating process. Tradeoffs are made in performance and other systems design parameters to achieve lower overall system costs. A variation of this method is cost-as-the-independent-variable , where the estimators start with a fixed system-level budget and work backwards, prioritizing and selecting requirements to bring the project scope within budget constraints. Computer Tools Computer tools are used extensively to assist in cost estimation. These range from spreadsheets and project management software to specialized simulation and estimating tools. Computer tools reduce the incidence of calculation errors, speed up the estimation process, and allow consideration of multiple costing alternatives. One of the more widely used computer tools for estimating software development costs is the Constructive Cost Model (COCOMO). The software and users manual are available for download without cost (see COCOMO in the Resources.) However, please note that most computer tools for developing estimates for software development use either lines of code or function points as input data. If the number of lines of code or function points cannot be accurately estimated, the output of the tools will not be accurate. The best use of tools is to derive ranges of estimates and gain understanding of the sensitivities of those ranges to changes in various input parameters. The outputs of the estimating process include the project cost estimates, along with the details used to derive those estimates. The details usually define the tasks by references to the WBS. They also include a description of how the cost was derived, any assumptions made, and a range for estimate (e.g. $20,000 +/- $2000.) Another output of the estimating process is the Cost Management Plan. This plan describes how cost variances will be managed, and may be formal or informal. The following information may be considered for inclusion in the plan: Cost and cost-related data to be collected and analyzed. Frequency of data collection and analysis. Sources of cost-related data. Methods of analysis. Individuals and organizations involved in the process, along with their responsibilities and duties. Limits of acceptable variance between actual costs and the baseline. The authority and interaction of the cost control process with the change control process. Procedures and responsibilities for dealing with unacceptable cost variances. Cost Budgeting Once the costs have been estimated for each WBS task, and all these put together for an overall project cost, a project budget or cost baseline must be constructed. The budget is a spending plan, detailing how and at what rate the project funding will be spent. The budgeting process elements are shown in Figure 6-4. All project activities are not performed at once, resources are finite, and funding will probably be spread out over time. Cost estimates, WBS tasks, resource availability, and expected funding must all be integrated with the project schedule in a plan to apply funds to resources and tasks. Budgeting is a balancing act to ensure the rate of spending closely parallels the resource availability and funding, while not exceeding either. At the same time, task performance schedules must be followed so that all tasks are funded and completed before or by the end of the project schedule. The spending plan forms the cost baseline, which will be one of the primary measures of project health and performance. Deviations from this cost baseline are major warning signs requiring management intervention to bring the project back on track. Various tools and techniques are available to assist in the budgeting process. Most of these are implemented in some form of computer software. Budgeting is usually a major part of project management software. Cost Control Cost control is the final step of the cost management process but it continues through the end of the project. It is a major element of project success and consists of efforts to track spending and ensure it stays within the limits of the cost baseline. The following activities make up the cost control process: Monitor project spending to ensure it stays within the baseline plan for spending rates and totals. When spending varies from the plan determine the cause of variance, remembering that the variance may be a result of incorrect assumptions made when the original cost estimate was developed. Change the execution of the project to bring the spending back in line within acceptable limits, or recognize that the original estimate was incorrect, and either obtain additional funding or reduce the scope of the project. Prevent unapproved changes to the project and cost baseline. When it is not possible to maintain the current cost baseline, the cost control process expands to include these activities: Manage the process to change the baseline to allow for the new realities of the project (or incorrectly estimated original realities.) Accurately record authorized changes in the cost baseline. Inform stakeholders of changes. The cost control process compares cost performance reports with the cost baseline to detect variances. Guidance on what constitutes unacceptable variance and how to deal with variance can be found in the cost management plan, developed during the estimation activities. Few projects are completed without changes being suggested or requested. All change requests should run the gauntlet of cost control to weigh their advantages against their impact to project costs. Cost control tools include performance measurement techniques, a working cost change control system, and computer based tools. A powerful technique used with considerable success in projects is Earned Value Management , if used appropriately. It requires a fully defined project up front and bottom-up cost estimates, but it can provide accurate and reliable indication of cost performance as early as 15% into the project. The outputs of cost control include products which are ongoing throughout the life of the project: revised cost estimates, budget updates, corrective actions, and estimates of what the total project cost will be at completion. Corrective actions can involve anything that incurs cost, or even updating the cost baseline to realign with project realities or changes in scope. Cost data necessary to project closeout are also collected throughout the life of the project and summarized at the end. A final product, extremely important to future efforts, is a compilation of lessons learned during the execution of the project. Tools for analyzing/evaluating Cost Management Some construction insurance projects dont only exceed their budget because they turn out to be bigger than originally estimated. They often blow the budget because the estimates were badly managed. As a result, the profitability analyses are not well quantified because the estimates of future return were not accurate. Accurate estimates turn to be really important, as they are frequently required for three principal reasons: The first is to well-define the costs/budget of the project. The second is to justify the project. It enables the cost to be compared with the anticipated benefits. The third is to evaluate and control the actual costs vs. estimated and take corrective actions when needed to make the project succeed. Applying Activity-Based Costing (ABC) to construction projects can help insurance companies to better understand their costs and maximize construction resources. Combined with the Earned Value Management, construction projects can be tracked and controlled effectively in terms of time and budget. Activity-Based Costing (ABC) Activity Based Costing (ABC) is a method for developing cost estimates in which the project is subdivided into discrete, quantifiable activities or a work unit. The activity must be definable where productivity can be measured in units (e.g., number of samples versus man hours). After the project is broken into its activities, a cost estimate is prepared for each activity. These individual cost estimates will contain all labour, materials, equipment, and subcontracting costs, including overhead, for each activity. Each complete individual estimate is added to the others to obtain an overall estimate. Contingency and escalation can be calculated for each activity or after all the activities have been summed. ABC is a powerful tool, but it is not appropriate for all cost estimates. This chapter outlines the ABC method and discusses applicable uses of ABC. ABC methodology is used when a project can be divided into defined activities. These activities are at the lowest function level of a project at which costs are tracked and performance is evaluated. Depending on the project organization, the activity may coincide with an element of the work breakdown structure (WBS) or may combine one or more elements of the WBS. However, the activities must be defined so there is no overlap between them. After the activity is defined, the unit of work is established. All costs for the activity are estimated using the unit of work. The estimates for the units of work can be done by performing detailed estimates, using cost estimating relationships, obtaining outside quotes for equipment, etc. All costs including overhead, profit, and markups should be included in the activity cost. Earned Value Management (EVM) An interesting phenomenon exists in the construction industry. The industry probably uses parts of Earned Value management about as well as any industry. But, what makes it interesting is that in construction work, practitioners rarely use the term Earned Value. The Earned Value Management (EVM) technique is a valuable tool to measure a projects progress, forecast its completion date and final cost, and provide schedule and budget variances along the way. Earned Value management is a technique that can be applied, at least in part, to the management of all capital projects, in any industry, while employing any contracting approach. The employment of Earned Value requires a three-dimensional measurement of project performance, ideally from as early as possible—perhaps as early as 15 percent complete, up to 100 percent final completion. However, two of the three dimensions of Earned Value—the baseline plan and the physical performance measurement—will apply to all capital projects, in any industry, using any contracting method. Using Earned Value metrics, any project can accurately monitor and measure the performance of projects against a firm baseline. Using the three dimensions of Earned Value, the project management teams can at all times monitor both the cost and the schedule performance status of their projects. The Earned Value Management (EVM) technique is a valuable tool to measure a projects progress, forecast its completion date and final cost, and provide schedule and budget variances along the way. EVM provides consistent indicators to evaluate and compare projects and give an objective measurement of how much work has been accomplished. It lets the project manager combine schedule performance and cost performance to answer the question: What did we get for the money we spent? Using EVM process, management can easily compare the planned amount of work with what has actually been completed, to determine if cost, schedule, and work accomplished are progressing as planned. It forces the project manager to plan, budget and schedule the work in a time-phased plan. The principles of ABC and EVM techniques provide innovative cost and performance measurement systems, allowing productivity improvements, and therefore can enhance the projects profitability and performance. Quality Management (QM) The process of planning, organizing, implementing, monitoring, and documenting a system of management practices that coordinate and direct relevant project resources and activities to achieve quality in an efficient, reliable, and consistent manner. Quality Management Plan (QMP) A project-specific, written plan prepared for certain projects which reflects the general methodology to be implemented by the Construction Manager during the course of the project to enhance the owners control of quality through a process-oriented approach to the various management tasks for the program. The Quality Management Plan complements the Construction Management Plan (CMP) and forms a basis of understanding as to how the project team will interrelate in a manner that promotes quality in all aspects of the program, from the pre-design phase through completion of construction. Its purpose is to emphasize the quality goals of the project team in all issues associated with the work. This pertains not only to the traditional QA/QC of constructing elements of the work, but also addresses the quality needs of management tasks such as performing constructability reviews during design, checking estimates, making appropriate decisions, updating schedules, guiding the selection of sub contractors and vendors from a quality-oriented basis, to dealing with the public when applicable. Owners, for certain projects, require that a separate Quality Management Plan be prepared by the Construction Manager. In these cases, the QMP is a project-specific plan which reflects the approach of the CM towards achieving quality in the constructed project. It is developed with heavy reliance on many of the sections included in these Guidelines, and fully supports the Construction Management Plan (CMP). When a separate QMP is prepared, most of the quality-oriented issues and discussion of processes, check lists, audits, etc., are contained in the QMP rather than the CMP. The CMP then addresses the day-to-day performance of the various functions and outlines the methods by which the Construction Managers forces will perform their services. The QMP typically will include some of the following: †¢ Overall project organization †¢ Project QA/QC organization †¢ QA/QC representatives of design team and contractors †¢ Management decision flow chart †¢ Formats for various elements of the CM services (i.e., formats for job meeting minutes, progress payment applications, field observation reports, shop drawing logs, notice of proposal change order, etc.) †¢ Detailed check lists or audit plans to provide for quality in the practice of CM functions (i.e., check lists for approving contractors schedules, approving revisions to schedules, reviewing change order costs, obtaining approval within the owner organization for changes, approval to start foundation construction, approval to start concrete pour, approval to start steel erection, preliminary and final acceptance, etc.). †¢ Project Quality Audit forms The CM will prepare quality management narratives for the use of his staff for each of the check lists and quality procedures contained in the QMP to provide for an acceptable level of quality at all levels of CM practice. Inputs to Quality Planning. Quality policy . Quality is the overall intentions and direction of a construction organization with regard to quality, as formally expressed by top management. The quality policy of the performing organization can often be adopted as is for use by the project. However, if the performing organization lacks a formal quality policy, or if the project involves multiple performing organizations (as with a joint venture), then the project management team will need to develop a quality policy for the project. Regardless of the origin of the quality policy, the project management team is responsible for ensuring that the project clients are fully aware of it. Scope statement. The scope statement is a key input to quality planning since it documents major project deliverables, as well as the project objectives that serve to define important client requirements. Project description. Although objectives of the project description may be embodied in the scope statement, the project description will often contain details of technical issues and other concerns that may affect quality planning. Standards and regulations. The project management team must consider any application area-specific standards or regulations that may affect the project. Other process outputs . In addition to the scope statement and project description, processes in other knowledge areas may produce outputs that should be considered as part of quality planning. For example, procurement planning may identify contractor quality requirements that should be reflected in the overall quality management plan. Tools and Techniques for Quality Planning. Benefit/cost analysis . The quality planning process must consider benefit/cost tradeoffs. The primary benefit of meeting quality requirements is less rework, which means higher quality, lower costs, and increased client satisfaction. The primary cost of meeting quality requirements is the expense associated with project management activities. It is axiomatic of the quality management discipline that the benefits outweigh the costs. Benchmarking. Benchmarking involves comparing actual or planned project practices to those of other projects to generate ideas for improvement and to provide a standard by which to measure performance. The other projects may be within the performing organization or outside of it, and may be within the same application area or in another. Flowcharting. A flow chart is any diagram that shows various elements of a system relate. Flowcharting techniques commonly used in quality management include: Cause-and-effect diagrams A cause-and-effect diagram is an analysis tool that provides a systematic way of looking at effects and the causes that create or contribute to those effects. It was develop by Dr. Kaoru Ishikawa of Japan in 1943 and is sometimes referred to as an Ishikawa Diagram or a Fishbone Diagram because of its shape. Cause-and-effect diagrams, also called Ishikawa diagrams or fishbone diagrams, which illustrate how various factors might be linked to potential problems or effects. A Cause-and-Effect Diagram is a tool that helps identify, sort, and display possible causes of a specific problem or quality characteristic. It graphically illustrates the relationship between a given outcome and all the factors that influence the outcome. A Cause-and-Effect Diagram is a tool that is useful for identifying and organizing the known or possible causes of quality, or the lack of it. The structure provided by the diagram helps team members think in a very systematic way. At the head of the Fishbone is the defect or effect, stated in the form of a question. The major bones are the capstones, or main groupings of causes. The minor bones are detailed items under each capstone. Applying cause-and-effect diagram A cause-and-effect diagram is a tool that is useful for identifying and organizing the known or possible causes of quality, or the lack of it. The structure provided by the diagram helps team members think in a very systematic way. Some of the benefits of constructing a cause-and-effect diagram are that it: helps determine the root causes of a problem or quality characteristic using a structured approach; encourages group participation and utilizes group knowledge of the process; uses an orderly, easy-to-read format to diagram cause-and-effect relationships; indicates possible causes of variation in a process; increases knowledge of the process by helping everyone to learn more about the factors at work and how they relate; and identifies areas where data should be collected for further study. System or process flow charts, which show how various elements of a system, interrelate. Flow chart is used to provide a diagrammatic picture using a set of symbols. They are used to show all the steps or stages in a process project or sequence of events. A flowchart assists in documenting and describing a process so that it can be examined and improved. Analyzing the data collected on a flowchart can help to uncover irregularities and potential problem points. Flowcharts, or Process Maps, visually represent relationships among the activities and tasks that make up a process. They are typically used at the beginning of a process improvement event; you describe process events, timing, and frequencies at the highest level and work downward. At high levels, process maps help you understand process complexity. At lower levels, they help you analyze and improve the process Pareto Analysis A Pareto Chart is a series of bars whose heights reflect the frequency or impact of problems. The bars are arranged in descending order of height from left to right. This means the categories represented by the tall bars on the left are relatively more significant than those on the right. The chart gets its name from the Pareto Principle, which postulates that 80 percent of the trouble comes from 20 percent of the problems. It is a technique employed to prioritize the problems so that attention is initially focused on those, having the greatest effect. It was discovered by an Italian economist, named Vilfredo Pareto, who observed how the vast majority of wealth (80%) was owned by relatively few of the population (20%). As a generalized rule for considering solutions to problems, Pareto analysis aims to identify the critical 20% of causes and to solve them as a priority. The use Pareto Charts You can think of the benefits of using Pareto Charts in economic terms. A Pareto Chart: breaks big problem into smaller pieces; identifies most significant factors; and helps us get the most improvement with the resources available by showing where to focus efforts in order to maximize achievements. The Pareto Principle states that a small number of causes accounts for most of the problems. Focusing efforts on the vital few causes is usually a better use of valuable resources. Applying Pareto Chart A Pareto Chart is a good tool to use when the process you are investigating produces data that are broken down into categories and you can count the number of times each category occurs. No matter where you are in your process improvement efforts, Pareto Charts can be helpful, .early on to identify which problem should be studied, later to narrow down which causes of the problem to address first. Since they draw everyones attention to the vital few important factors where the payback is likely to be greatest, (they) can be used to build consensus. In general, teams should focus their attention first on the biggest problems-those with the highest bars. Making problem-solving decisions isnt the only use of the Pareto Principle. Since Pareto Charts convey information in a way that enables you to see clearly the choices that should be made, they can be used to set priorities for many practical applications in your command. S