Lecture 17&18.ppt.pdf

Project Cost Management
Information Technology Project Management

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Information Technology Project Management, Fourth Edition
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 examined IT change initiatives in almost 1,500
projects and reported an average cost overrun of 27 percent
▪ One in six of all projects studied contained a “black swan”: a high-impact event
that is rare and unpredictable, but not improbable in retrospect
▪ These IT black swan projects had an average cost overrun of 200 percent and a
schedule overrun of almost 70 percent

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What is Cost and Project Cost Management?
▪ Cost is a resource sacrificed or foregone to achieve a specific objective
▪ Webster's dictionary defines cost as ‘something given up in exchange’
▪ Costs are usually measured in monetary units, such as dollars, that must be
paid to acquire goods and services
▪ Project cost management includes the processes required to ensure that
the project is completed within an approved budget

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Project Cost Management
▪ Project cost management includes the processes required to ensure
that a project team completes a project within an approved budget
▪ There are four processes for project cost management
▪ Planning cost management: determining the policies, procedures, and
documentation that will be used for planning, executing and controlling project
costs
▪ Estimating costs: developing an approximation or estimate of the costs
of the resources needed to complete a project
▪ Determining the budget: allocating the overall cost estimate to
individual work items to establish a baseline for measuring performance
▪ Controlling costs: controlling changes to the project budget

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Basic Principles of Cost Management
▪ Tangible costs or benefits:
⁃ Costs or benefits that an organization can easily measure in dollars. For example,
suppose that the Surveyor Pro project described in the chapter’s opening case included a
preliminary feasibility study. If a company completed this study for $100,000, its tangible cost is
$100,000
▪ Intangible costs or benefits
⁃ Costs or benefits that are difficult to measure in monetary terms. Suppose that Juan
and a few other people spent their own personal time using government-owned computers,
books, and other resources to research areas related to the study
▪ Direct costs
⁃ Costs that can be directly related to producing the products and services of the
project. For example, direct costs include the salaries of people working full time on the
project and the cost of hardware and software

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▪ Indirect costs
⁃ costs that are not directly related to the products or services of the project, but
are indirectly related to performing the project. For example, indirect costs would
include the cost of electricity and other necessities in a large building that houses 1,000
employees who work on many projects
▪ Sunk cost
⁃ money that has been spent in the past; when deciding what projects to invest in
or continue, you should not include sunk costs. For example, in the chapter’s opening
case, suppose that Juan’s office had spent $1 million on a project over the past three years
to create a geographic information system, but had never produced anything valuable

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▪ 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
⁃ For example, the first time a new employee performs a specific task, it will
probably take longer than the tenth time that employee performs a very similar
task. Effort estimates, therefore, should be lower for more experienced workers

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▪ 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. For example, if an organization knows it has a 20 percent rate of turnover
for IT personnel, it should include contingency reserves to pay for recruiting and
training costs of IT personnel
⁃ Management reserves allow for future situations that are unpredictable
(sometimes called unknown unknowns). For example, if a project manager gets
sick for two weeks or an important supplier goes out of business, management
reserve could be set aside to cover the resulting costs

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Cost Estimating
▪ 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

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Types of Cost Estimates

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Cost Management Plan
▪ A cost management plan is a document that describes how the
organization will manage cost variances on the project
▪ A large percentage of total project costs are often labor costs, so project
managers must develop and track estimates for labor.

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Cost Estimation Tools and Techniques
▪ Tools and techniques include expert judgment, analogous cost estimating,
bottom-up estimating, three-point estimating, parametric estimating, the cost of
quality, project management estimating software, vendor bid analysis, and
reserve analysis

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▪ Basic tools and techniques for cost estimates:
▪ 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
⁃ This technique requires a good deal of expert judgment and is generally less
costly than other techniques, but it is also less accurate
⁃ Analogous estimates are most reliable when the previous projects are similar in
fact, not just in appearance
⁃ Analogous (Top Down) estimating – Managers use expert judgment or similar
project costs [quick, less accurate]

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▪ Bottom-up estimates:
⁃ Involve estimating individual work items or activities and summing them to get a
project total. (It is sometimes referred to as activity-based costing)
⁃ The size of the individual work items and the experience of the estimators drive
the accuracy of the estimates
⁃ If a detailed WBS is available for a project, the project manager could require each
person who is responsible for a work package to develop a cost estimate for that
work
⁃ Bottom-Up estimating – People doing work estimate based on WBS, rolled up into
project estimate [slow, most accurate]

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▪ Parametric modeling:
▪ Uses project characteristics (parameters) in a mathematical model to
estimate project costs
▪ For example, a parametric model might provide an estimate of $50 per line of code for a
software development project based on the programming language the project is using,
the level of expertise of the programmers, the size and complexity of the data involved,
and so on
▪ Parametric models are most reliable when the historical information used to create
the model is accurate, the parameters are readily quantifiable, and the model is
flexible in terms of the project’s size

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▪ Basic tools and techniques for cost estimates:
▪ Computerized tools: Tools, such as spreadsheets and project management
software, that can make working with different cost estimates and cost estimation
tools easier

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▪ In practice, many people find that using a combination or hybrid approach with
analogous, bottom-up, three-point, and parametric estimating provides the best cost
estimates

How Do We Manage Cost?
▪ Three processes
▪ Cost Estimating
▪ Cost Budgeting
▪ Cost Control
Cost Estimating Cost Budgeting Cost Control
Information Technology Project Management, Fourth Edition 22

Cost Estimating
Enterprise
Environmental
Factors
Organizational
Process Assets
Project Scope
Statement
❑ Analogous estimating
❑ Determine resource cost rates
❑ Bottom up estimating
❑ Parametric estimating
❑ Project management software
❑ Vendor bid analysis
❑ Reserve analysis
❑ Cost of quality
Inputs
Outputs
Tools & Techniques
Work Breakdown
Structure
WBS Dictionary
Project Management
Plan
•Schedule Mgmt Pln
•Staffing Mgmt Pln
•Risk Register
Activity Cost
Estimates
Activity Cost
Estimates Supporting
Detail
Requested Changes
Cost Management
Plan Updates

Cost Budgeting
Project Scope Statement ❑ Cost aggregation
❑ Reserve analysis
❑ Parametric estimating
❑ Funding limit reconciliation
Inputs
Outputs
Tools & Techniques
Cost Baseline
Project Funding
Requirements
Cost Management
Plan Updates
Requested Changes
Work Breakdown Structure
WBS Dictionary
Activity Cost Estimates
Activity Cost Estimates
Supporting Detail
Project Schedule
Resource Calendars
Contract
Cost Management Plan

Cost Control
Cost Baseline
Project Funding
Requirements
Performance
Reports
❑ Cost change control system
❑ Performance measurement
analysis
❑ Forecasting
❑ Project performance reviews
❑ Project management software
❑ Variance management
Inputs
Outputs
Tools & Techniques
Work Performance
Information
Approved Change
Requests
Project Management
Plan
Cost Estimate Updates
Cost Baseline Updates
Performance
Measurements
Forecasted Completion
Requested Changes
Recommended
Corrective Actions
Organizational Process
Assets Updates
Project Management
Plan Updates

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Typical Problems with IT Cost Estimates
▪ Estimates are done too quickly
Developing an estimate for a large software project is a complex task that requires
significant effort. Many estimates must be done quickly and before clear system
requirements have been produced
▪ People lack estimating experience
The people who develop software cost estimates often do not have much experience
with cost estimation, especially for large projects. They also do not have enough
accurate, reliable project data on which to base estimates

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Typical Problems with IT Cost Estimates
▪ Human beings are biased toward underestimation
For example, senior IT professionals or project managers might make estimates based
on their own abilities and forget that many younger people will be working on a project.
Estimators might also forget to allow for extra costs needed for integration and testing
on large IT projects
▪ Management desires accuracy
Management might ask for an estimate but really want a more accurate number to help
them create a bid to win a major contract or get internal funding

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Constructive Cost Model (COCOMO)
▪ Barry Boehm helped develop the COCOMO models for estimating software
development costs.
▪ Parameters include:
⁃ Function points:Technology-independent assessments of the functions
involved in developing a system
⁃ Source Lines of Code (SLOC): A human-written line of code that is
not a blank line or comment
▪ Boehm suggests that only parametric models do not suffer from the limits of
human decision-making

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Figure 7-1. Surveyor Pro Project Cost Estimate

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EarnedValue 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. i.e. Progress is compared against
the baseline to determine whether the project is ahead of or behind the plan
▪ You must enter actual information periodically to use EVM
▪ More and more organizations around the world are using EVM to help
control project costs

Cost Management Key Terms
▪ PV –
PlannedValue, the estimated value of the planned work Budgeted Cost
▪ EV –
EarnedValue, the estimated value of work done Actual work completed (estimate of the value of the
physical work actually completed)
▪ AC –
Actual Cost, what you paid (total of direct and indirect costs incurred in accomplishing work on an
activity during a given period)
▪ BAC –
Budget at Completion, the budget for the total job
▪ EAC –
Estimate at Completion, what is the total job expected to cost? What final cost will be
▪ ETC –
Estimate to Complete, forecasted costs to complete job What’s Left
▪ VAC –
Variance at Completion, how much over/under budget do we expect to be?
▪ 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
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CONTROL COSTS:TOOLS & TECHNIQUES
Variances from the approved baseline will also be monitored:
▪ ScheduleVariance (SV). – SV = EV – PV
A measure of schedule performance is expressed as the difference between
the EarnedValue (EV) and the PlannedValue (PV)
▪ CostVariance (CV). – CV = EV – AC
The amount of budget deficit or surplus at a given point in time expressed as
the difference between EarnedValue (EV) and the Actual Cost (AC)

Variances from the approved baseline will also be monitored:
▪ Schedule Performance Index (SPI) – SPI = EV/PV
A measure of efficiency is expressed as the ratio of EarnedValue to PlannedValue.
An SPI value of LESS than 1.0 means that it is behind schedule and GREATER than
1.0 means that it’s ahead of the schedule
▪ Cost Performance Index (CPI) – CPI = EV/AC
A measure of cost efficiency of budgeted resources is expressed as the ratio
between EarnedValue to Actual Cost. A CPI value of LESS than 1.0 means that it is
Over Budget and GREATER than 1.0 means that it’s Under Budget

EarnedValue Formulas
NAME FORMULA NOTES
Cost Variance (CV) EV-AC Negative = Over budget
Positive = Under budget
Schedule Variance
(SV)
EV-PV Negative = Behind Schedule
Positive = Ahead of Schedule
Cost Performance
Index (CPI)
EV/AC How much are we getting for every
dollar we spend?
Schedule Perform
Index (SPI)
EV/PV Progress as % against plan
Estimate to Complete
(ETC)
EAC-AC How much more do we have to
spend?
Variance at
Completion (VAC)
BAC-EAC At the end of the day, how close will
we be to plan?
Estimate at
Completion (EAC)
See following slide
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EarnedValue Formulas (Cont’d)
NAME FORMULA NOTES
Estimate at
Completion (EAC)
•BAC/CPI •Use if no variances from
BAC have occurred
•AC+ATC •Use when original estimate
was bad. Actuals + New
estimate
•AC+BAC-EV •Use when current
variances are not expected
to be there in the future
•AC+(BAC-EV)/CPI •Use when current
variances are expected to
continue 35

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Table 7-4. EarnedValue Calculations for One Activity
After Week One

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EarnedValue Formulas

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Rules of Thumb for EarnedValue Numbers
▪ Negative numbers for cost and schedule variance indicate problems in those
areas
▪ A CPI or SPI that is less than 100 percent indicates problems
▪ Problems mean the project is costing more than planned (over budget) or
taking longer than planned (behind schedule)

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Project Portfolio Management
▪ Many organizations collect and control an entire suite of projects or
investments in a portfolio as one set of interrelated activities.
▪ Project portfolio management has five levels:
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 the type of
investment.
4. Automate the repository.
5. Apply modern portfolio theory, including risk-return tools that map
project risk on a curve.

Forecasting
As the project progresses, the PM may develop a forecast for the Estimate At
Completion (EAC) that may differ from the Budget At Completion (BAC) based on
performance. If the BAC is deemed no longer viable, the forecasted EAC will be
used.
EACs are typically based on actual cost incurred, plus an Estimate to Complete
(ETC) the remaining work.
The most common EAC forecasting approach is a manual bottom-up summation by
the PM & the project team.
EAC = AC + Bottom-Up ETC

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