A project can only come together with all the necessary materials and labor, and those materials and labors cost money. A Cost estimate is a quantified expectation of how many resources are required to complete a project or parts of a project. Such cost estimates are often expressed in currency units. However, other units such as man-days can also be used if the currency amounts are not applicable or irrelevant.
Cost estimation in project management is the process of forecasting the financial and other resources needed to complete a project within a defined scope. Cost Management is one of the primary functions of Project Managers. This is because a project is defined as being subject to at least three fundamental constraints: scope, budget, and time. Projects bring risks, and risks bring unexpected costs and cost management issues.
Estimating cost is an important process in project management as it is the basis for determining and controlling the project budget, which is subject to the approval of the project sponsor(s). Cost estimation is the process that takes direct costs, indirect costs and other factors into account, and calculates a budget that meets the financial commitment necessary for a successful project.
A project’s budget has the potential to impact nearly every facet of the project, making it one of the most critical responsibilities of a project manager. A poorly designed budget leads to improper asset allocation, unrealistic expectations, and potentially, a failed project.
There are two key types of costs addressed by the cost estimation process:
- Direct costs: Costs associated with a single area, such as a department or the project itself. Examples of direct costs include fixed labor, materials, and equipment.
- Indirect costs: Costs incurred by the organization at large, such as utilities and quality control.
Within these two categories, here are some typical elements that a cost estimation will take into account:
- Labor: The cost of team members working on the project, both in terms of wages and time
- Materials and equipment: The cost of resources required for the project, from physical tools to software to legal permits
- Facilities: The cost of using any working spaces not owned by the organization.
- Vendors: The cost of hiring third-party vendors or contractors.
- Risk: The cost of any contingency plans implemented to reduce risk.
By its very nature, a cost estimate is uncertain. Quantifying this inherent uncertainty provides useful additional information to the decision-maker. Uncertainty in cost estimates arises from many sources and may be grouped into three categories: requirements, cost estimating, and technical.
NASA needs estimates for Project Office formulation and implementation phases, non advocate cost estimates, source selections, what-if exercises, affordability studies, economic analyses, and Analysis of Alternatives (AoA), as well as to support numerous types of decisions related to projects.
Life cycle cost (LCC)
Life cycle cost (LCC) can be defined as the total cost to the government of a program over its full life, including costs for research and development, testing, production, facilities, operations, maintenance, personnel, environmental compliance, and disposal. Being almost universal in scope, the LCC concept has come to be known by various names such as Whole Life Cost, Cost of Ownership, or Total Ownership Cost (TOC).
Total Ownership Cost (TOC) is defined as the sum of financial resources needed to organize, equip, sustain, and operate the system while meeting national goals, policies, and standards of readiness, environmental compliance, safety, and quality of life concerns. The TOC of a Defense system should be the same as its Life Cycle Cost (LCC). The cost estimates must be developed, updated, and managed over the total life-cycle of any asset and are an important element for total life-cycle asset management.
The parameters and driving factors for availing any optimum option in the case of Life Cycle Costing (as per the methodology adopted by NATO) are based on an assessment of the expenditure which may go into the maintenance of a particular system, for comparison among the available alternative solutions, to manage the demands vis-a-vis existing budget, options for acquisition, and assessment of cost reduction opportunities.
In light of shrinking defense budgets, DoD is focusing on reducing the overall cost of the DoD
establishment and its major subdivisions (i.e., the DoD Components), with the goal of freeing up
funding for modernization and recapitalization of weapon systems.
Research & Development (R&D): Cost of all research and development, from program initiation through the Full Rate Production decision (end of engineering and manufacturing development for grandfathered programs).
Investment: Cost of the investment phase, including total cost of procuring the prime
equipment; related support equipment; training; initial and war reserve spares; pre-planned
product improvements and military construction.
Operating and Support (O&S): Cost of operating and supporting the fielded system,
including all direct and indirect costs incurred in using the system, e.g., personnel, maintenance
(unit and depot), and sustaining investment (replenishment spares). The bulk of life cycle costs
occur in this category.
Disposal: Cost to dispose of the system after its useful life. This includes demilitarization, detoxification, long-term waste storage, environmental restoration and related costs.
Life cycle cost estimates are essential sources of information for the materiel acquisition
process. They provide the cost information to support the acquisition milestone decision process
as well as the development of acquisition program budget requests
Cost estimating is the process of assembling and predicting costs of a project over its life cycle. It encompasses the three phases included in the initial function chart; namely, economic evaluation, project investment cost and cost forecasting.
The economic evaluation is the initial planning phase to determine whether a project is economically and technically feasible and whether sufficient funding can be obtained to implement the project. It involves the assessment of “order of magnitude” estimates, project profitability, financing and acceptance.
The project investment cost is the prediction of future cost even though all the parameters are not fully defined at times during the project’s life. It is during this process that order of magnitude, budget and definitive estimates are produced.
Cost forecasting is the process of developing the future trends along with the assessment of probabilities, uncertainties and inflation that could occur during the project.
The combination of these three processes assist in predicting the future financial outcome for a successful project.
The cost budgeting process is one of establishing budgets, standards and a monitoring system by which the investment cost of the project can be measured and managed. This process is the planning phase once project approval is obtained. It includes all the accounting functions required to establish procedures and systems to monitor the project.
The process of cost control is the gathering, accumulating, analyzing, monitoring, reporting and managing the costs on an ongoing basis.
Project Cost Estimation Techniques
The first point to estimate cost is during the initiation phase, e.g. when the project business case or the project charter is created. For these documents, a project manager has to determine the number of resources that are required to complete the project. Initial, high-level estimates are often used in the earliest stages of project planning and can determine whether or not a project is ultimately pursued. Once a project is approved and an organization chooses to move forward with it, more detailed and granular cost estimates become necessary in order to appropriately allocate various resources.
1. Analogous Estimating
Through analogous estimating, a project manager calculates the expected costs of a project-based upon the known costs associated with a similar project that was completed in the past. This method of estimation relies upon a combination of historical data and expert judgment of the project manager.
Because no two projects are exactly the same, analogous estimating does have its limitations. As such, it is often leveraged in the earliest stages of project planning, when a rough estimate can suffice. Analogous estimating can also be used when there is relatively little information about the current project available.
2. Parametric Estimating
In parametric estimating, historical data and statistical modeling are used to assign a dollar value to certain project costs. This approach determines the underlying unit cost for a particular component of a project and then sales that unit cost as appropriate. It is much more accurate than analogous estimating but requires more initial data to accurately assess costs.
Parametric estimating is often used in construction. For example, an experienced construction manager might understand that the typical new home will cost a certain number of dollars per square foot (assuming a particular margin of error). If this average cost, the margin of error, and the square footage of a new project are known, then parametric estimating will allow them to identify a budget that should accurately fall within this range. Other examples might include estimating the cost per unit to print and bind a book or to build an electronic device.
3. Bottom-Up Estimating
In bottom-up estimating, a larger project is broken down into a number of smaller components. The project manager then estimates costs specifically for each of these smaller work packages.
A program WBS provides a framework for program and technical planning, cost estimating, resource allocations, performance measurements, and status reporting.
For example, if a project includes work that will be split between multiple departments within an organization, costs might be split out by department. Once all costs have been estimated, they are tallied into a single larger cost estimate for the project as a whole. Because bottom-up estimating allows a project manager to take a more granular look at individual tasks within a project, this technique allows for a very accurate estimation process.
4. Three-Point Estimating
In three-point estimating, a project manager identifies three separate estimates for the costs associated with a project. The first point represents an “optimistic” estimate, where work is done and funds spent most efficiently; the second point represents the “pessimistic” estimate, where work is done and funds spent in the least efficient manner; and the third point represents the “most likely” scenario, which typically falls somewhere in the middle. Three-point estimating relies on a number of weighted formulas and originates from the Program Analysis and Review Technique (PERT).
References and Resources also include: