MIS 4374: Lecture 7-Ch.7 Project Cost Management

Cost Estimation Tools and Techniques

- Basic tools and techniques for cost estimates: - Analogous or top-down estimates -Bottom-up estimates -Parametric modeling

Determine Budget

allocating the overall cost estimate to individual work items to establish a baseline for measuring performance

Control Costs

controlling changes to the project budget

Determining the Budget

- 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 - Important goal is to produce a cost baseline - a time-phased budget that project managers use to measure and monitor cost performance

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 - Project cost management includes the processes required to ensure that the project is completed within an approved budget

Earned Value Management (EVM)

- EVM is a project performance measurement technique that integrates scope, time, and cost data - Given a baseline (original plan plus approved changes), you can determine how well the project is meeting its goals - You must enter actual information periodically to use EVM - More and more organizations around the world are using EVM to help control project costs

Global Issues

- EVM is used worldwide, and it is particularly popular in the Middle East, South Asia, Canada, and Europe - Most countries require EVM for large defense or government projects - EVM is also used in such private-industry sectors as IT, construction, energy, and manufacturing. - However, most private companies have not yet applied EVM to their projects because management does not require it, feeling it is too complex and not cost effective

Typical Problems with IT Cost Estimates

- Estimates are done too quickly - People lack estimating experience - Human beings are biased toward underestimation - Management desires accuracy

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 (the additional percentage or dollar amount by which actual costs exceed estimates) ranged from 180 percent in 1994 to 43 percent in 2010 - A 2011 Harvard Business Review study reported an average cost overrun of 27 percent. The most important finding was the discovery of a large number of gigantic overages or "black swans"

More Basic Principles of Cost Management

- Learning curve theory states that when many items are produced repetitively, the unit cost of those items decreases in a regular pattern as more units are produced - 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 - Management reserves allow for future situations that are unpredictable (sometimes called unknown unknowns

Project Portfolio Management

- Many organizations collect and control an entire suite of projects or investments as one set of interrelated activities in a portfolio - One method for project portfolio management 1. Put all your projects in one database 2. Prioritize the projects in your database 3. Divide your projects into two or three budgets based on type of investment 4. Automate the repository 5. Apply modern portfolio theory, including risk- return tools that map project risk on a curve

Basic Principles of Cost Management

- Most members of an executive board better understand and are more interested in financial terms than IT terms, so IT project managers must speak their language - Profits are revenues minus expenditures - Profit margin is the ratio of revenues to profits - Life cycle costing considers the total cost of ownership, or development plus support costs, for a project - Cash flow analysis determines the estimated annual costs and benefits for a project and the resulting annual cash flow

Rules of Thumb for Earned Value Numbers

- Negative numbers for cost and schedule variance indicate problems in those areas - CPI and SPI less than 100% indicate problems - Problems mean the project is costing more than planned (over budget) or taking longer than planned (behind schedule) - The CPI can be used to calculate the estimate at completion (EAC)—an estimate of what it will cost to complete the project based on performance to date. The budget at completion (BAC) is the original total budget for the project

Project Cost Management Processes

- Plan cost management - Estimate Costs - Determine Budget - Control Costs

Earned Value Management Terms

- Planned Value (PV) - Actual cost (AC) - Earned value (EV)

Controlling Costs

- 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

Estimating Costs (cont)

- 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

Rate of Performance

- Rate of performance (RP) is the ratio of actual work completed to the percentage of work planned to have been completed at any given time during the life of the project or activity - Brenda Taylor, Senior Project Manager in South Africa, suggests this term and approach for estimating earned value - For example, suppose the server installation was halfway completed by the end of week 1. The rate of performance would be 50% because by the end of week 1, the planned schedule reflects that the task should be 100 percent complete and only 50 percent of that work has been completed

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 Portfolio management software can help reduce costs

Types of Costs and Benefits

- Tangible costs or benefits are those costs or benefits that an organization can easily measure in dollars. - Intangible costs or benefits are costs or benefits that are difficult to measure in monetary terms. - Direct costs are costs that can be directly related to producing the products and services of 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. - 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.

More on Cost Estimates

- The number and type of cost estimates vary by application area. The Association for the Advancement of Cost Engineering International identifies five types of cost estimates for construction projects: order of magnitude, conceptual, preliminary, definitive, and control - Estimates are usually done at various stages of a project and should become more accurate as time progresses - A large percentage of total project costs are often labor costs

Planning cost management (cont)

- The project team uses expert judgment, analytical techniques, and meetings to develop the cost management plan - A cost management plan includes:- Level of accuracy and units of measure - Organizational procedure links - Control thresholds - Rules of performance measurement - Reporting formats - Process descriptions

Earned value (EV)

- formerly called the budgeted cost of work performed (BCWP), is an estimate of the value of the physical work actually completed - EV is based on the original planned costs for the project or activity and the rate at which the team is completing work on the project or activity to date

Cost Performance Index (CPI) Formula

CPI = EV/AC

Cost variance (CV) Formula

CV = EV - AC

Estimate at Completion (EAC) Formula

EAC = BAC / CPI

Earned Value Formula

EV = PV to date * RP

Estimated time to complete Formula

Original time estimate / SPI

Schedule Performance Index (SPI) Formula

SPI = EV/PV

Schedule Variance (SV) Formula

SV = EV - PV

Planning Cost Management

determining the policies, procedures, and documentation that will be used for planning, executing, and controlling project cost.

Estimating Costs

developing an approximation or estimate of the costs of the resources needed to complete a project

Actual cost (AC)

formerly called actual cost of work performed (ACWP), is the total of direct and indirect costs incurred in accomplishing work on an activity during a given period

Planned Value (PV)

formerly called the budgeted cost of work scheduled (BCWS), also called the budget, is that portion of the approved total cost estimate planned to be spent on an activity during a given period

Bottom-up estimates

involve estimating individual work items or activities and summing them to get a project total

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

Parametric modeling

uses project characteristics (parameters) in a mathematical model to estimate project costs