Cost Estimation and ROI Fundamentals

Chapter 7: Project Cost Management

• IT projects frequently fail to meet budget goals.
• Cost overrun is the difference between actual and estimated costs.
• A 2011 Harvard Business Review study found an average cost overrun of 27%.
• The study highlighted "black swan" events, high-impact, rare, but not improbable incidents.
• The UK National Health Service IT modernization program experienced a significant $26 billion overrun.
• The program failed due to incompatible systems and disagreements among contractors.
• Cost is a resource sacrificed or foregone to achieve a specific objective, usually measured in monetary units.
• Project cost management involves processes to ensure project completion within the approved budget.
• Planning cost management involves defining policies, procedures, and documentation for cost planning, execution, and control.
• Estimating costs involves developing approximations for the cost of project resources.
• Determining the budget involves allocating the overall cost estimate to individual work items to establish a baseline.
• Controlling costs involves managing changes to the project budget.

Learning Objectives (1 of 2)

• Justify project cost management, its importance in achieving project success.
• Explain basic project cost management principles, concepts, and terms.
• Describe the process of planning cost management.
• Discuss different types of cost estimates and methods for preparing them.
• Provide an example of an IT project, outlining processes for determining the budget and cost estimates.

Learning Objectives (2 of 2)

• Justify the use of earned value management and project portfolio management for cost control.
• Describe how project management software can assist in project cost management.
• Discuss considerations for agile/adaptive environments.

The Importance of Project Cost Management

• IT projects frequently have a poor track record of meeting budget goals.
• Cost overrun represents the percentage or dollar amount by which actual costs exceed estimates.

What is Cost?

• Cost is a resource sacrificed or given up to achieve a specific objective.
• Cost is usually measured in monetary units like dollars.
• Cost is incurred to acquire goods and services.

What is Project Cost Management? (1 of 2)

• Project cost management ensures the project is completed within the approved budget.
• Planning cost management determines policies, procedures, and documentation for project cost planning.
• Estimating costs involves developing approximations of resource costs.
• Determining the budget involves allocating the overall estimated cost.
• Controlling costs involves managing budget changes.

What is Project Cost Management? (2 of 2)

• Detailed overview of project cost management processes, including inputs, tools & techniques, and outputs for planning cost management, estimating costs, determining the budget, and controlling costs.

Basic Principles of Cost Management (1 of 3)

• Executive board members often prefer financial terms over IT terms.
• Profit is calculated by subtracting expenditures from revenues.
• Profit margin is the ratio of profit to revenue.
• Life cycle costing considers the entire cost of ownership of a project.
• Cash flow analysis estimates annual project costs and benefits.

Basic Principles of Cost Management (2 of 3)

• Tangible costs/benefits are easily measured in dollars.
• Intangible costs/benefits are difficult to measure in monetary terms.
• Direct costs are directly related to project deliverables.
• Indirect costs are indirectly related to project deliverables.
• Sunk costs are past expenses, not to be considered in future decisions.

Basic Principles of Cost Management (3 of 3)

• Learning curve theory shows decreasing unit cost as production volume rises.
• Reserves are dollars for unpredictable future situations.
• Contingency reserves account for partially predictable future situations.
• Management reserves address unpredictable future situations.

Media Snapshot

• Return on investment (ROI) cannot be measured without a benefits measurement process.
• Many organizations lack formalized benefits measurement processes.
• A 2015 PMI report showed low benefits realization maturity across organizations.
• High-performing organizations demonstrate higher benefits realization maturity.

What Went Right?

• Investments in green IT have yielded environmental and financial benefits.
• Dell has achieved carbon neutrality and saved customers billions in energy costs.
• Dell aims to recover millions of pounds of electronic waste.

Planning Cost Management

• Project cost management begins with planning how costs will be managed throughout the project life cycle.
• Expert judgment, analytical techniques, and meetings are used to formulate the cost management plan.
• The cost management plan defines accuracy level, measurement units, organizational procedures, control thresholds, performance measurement rules, reporting formats, and process descriptions.

Estimating Costs (1 of 4)

• Project managers must seriously consider cost estimates to keep a project within its budget constraints.

Estimating Costs (2 of 4)

• Overview of different types of cost estimates (rough order of magnitude, budgetary, definitive).
• When each type of estimate is typically prepared, and why.
• Typical ranges for each type of estimate.

Estimating Costs (3 of 4)

• The number and type of cost estimates vary depending on the application area.
• The Association for the Advancement of Cost Engineering international identifies five types of cost estimations: order of magnitude; conceptual; preliminary; definitive; and control.
• Cost estimates improve in accuracy as the project progresses.
• Supporting details for cost estimates should be extensively documented.
• Labor costs often comprise a significant portion of total project costs.

Estimating Costs (4 of 4)

• Example of a cost estimate table.

Cost Estimation Tools and Techniques

• Analogous or top-down estimates use similar past projects as a basis.
• Bottom-up estimates sum costs for individual work items.
• Three-point estimates establish most likely, optimistic, and pessimistic cost scenarios.
• Parametric estimating incorporates parameters into a mathematical model for project cost estimation.

Typical Problems with IT Cost Estimates

• Reasons for inaccuracies in IT cost estimates, including estimating too quickly, lacking estimating experience, human bias toward underestimation, and management desire for accuracy.

How to Develop a Cost Estimate and Basis of Estimates (1 of 3)

• The need to gather information from the start to create a cost estimate for a project, like the Surveyor Pro Project.
• Gathering sufficient information on the project, clarifying ground rules and assumptions for cost estimation, consulting the organization's cost estimating plan to understand their usage priorities.

How to Develop a Cost Estimate and Basis of Estimates (2 of 3)

• Detailed example of creating a cost estimate for the Surveyor Pro project (including table).

How to Develop a Cost Estimate and Basis of Estimates (3 of 3)

• Detailed example of creating a cost estimate for the Surveyor Pro project with calculations.

Best Practice

• Alvin Alexander's book on cost estimation in agile development environments discusses cost estimation in agile environments.
• Function points measure software size from a user perspective.
• User stories simply describe project requirements.
• Developers leverage user stories to estimate internal logic file quantity from the project estimates.

Determining the Budget (1 of 2)

• Budgeting allocates the project cost estimate to individual work items over time.
• Work breakdown structure (WBS) activities are the foundation for material and resource allocation.
• Budget creation produces a time-phased baseline used by project managers to measure and monitor cost performance.

Determining the Budget (2 of 2)

• Detailed example of a project cost baseline.

Controlling Costs

• Project cost control activities involve cost performance monitoring, approving changes, and informing stakeholders of changes.
• Expert judgment, data analysis, project management information systems, and the to-complete performance index support cost control.

Earned Value Management (EVM) (1 of 5)

• EVM integrates project scope, time, and cost data to measure project performance against a baseline.
• A baseline integrates original plan + approved changes, to assess the project's success against objectives(scope, time, cost).
• EVM calculates planned value (PV), actual cost (AC), and earned value (EV).

Earned Value Management (EVM) (2 of 5)

• Example table of earned value calculations for a project activity.

Earned Value Management (EVM) (3 of 5)

• Key formulas for EVM calculations (CPI, SPI, etc.).

Earned Value Management (EVM) (4 of 5)

• Key EVM concepts (Cost Variance (CV), Schedule Variance (SV), Cost Performance Index (CPI), Schedule Performance Index (SPI), Estimate at Completion (EAC), To-Complete Performance Index (TCPI)).

Earned Value Management (EVM) (5 of 5)

• Visual representation of how EVM data is presented.

Global Issues (1 of 2)

• EVM is commonly used in Middle East, South Asia, Canada, and Europe.
• Government and defense projects are often required to employ EVM.

Global Issues (2 of 2)

• Percentage breakdown of EVM usage in different types of projects.

Project Portfolio Management

• Many organizations control multiple projects as an integrated portfolio.
• Project level management includes various strategies for project prioritization, database organization, investment categorization, repository automation, and the use of modern portfolio theory to evaluate risk/return.

Using Project Management Software to Assist in Project Cost Management (1 of 2)

• Spreadsheets are commonly used for project cost planning.
• Many companies use centralized financial applications.
• Project management software improves cost management effectiveness throughout the project life cycle.
• Some IT project managers may not utilize all the features of project management software.

Using Project Management Software to Assist in Project Cost Management (2 of 2)

• Recent research shows significant growth in project management software markets with increased ROI on project investments.
• Tools like Pfizer and Ford have used project portfolio management software to gain a broader understanding of project management transparency.

Considerations for Agile/Adaptive Environments

• Agile-adapted EVM utilises Scrum framework artifacts in traditional EVM metrics.
• Agile projects require minimal input parameters for proper calculations (costs, release plan, iterations, velocity).
• Estimating can include hours, story points, team days, or any other consistent sizing methods to maintain a common understanding across teams.

Chapter Summary

• Project cost management is often a weak area for IT projects.
• Effective cost management requires understanding cost management principles.
• The main processes for cost management are planning, estimating, determining the budget, and controlling costs.
• Software can greatly assist with cost management.

Explore essential concepts in cost estimation, return on investment, and project management through this quiz. Test your knowledge on profit calculations, user stories, and best practices for effective estimation. Ideal for anyone looking to deepen their understanding of financial metrics in business.