Chapter 7 Project Cost Management (1) Dr. Feng-Jen Yang

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1 Chapter 7 Project Cost Management (1) Dr. Feng-Jen Yang

2 Objectives Understand the importance of project cost management Explain basic project cost management principles, concepts, and terms Discuss different types of cost estimates and methods for preparing them Understand the processes involved in cost budgeting and preparing a cost estimate and budget for an information technology project Dr. Feng-Jen Yang 2

3 Objectives cont. Understand the benefits of earned value management and project portfolio management to assist in cost control Describe how project management software can assist in project cost management Dr. Feng-Jen Yang 3

4 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 ranged from 180% in 1994 to 56% in 2004 Other studies found overruns to be 33-34% Dr. Feng-Jen Yang 4

5 What is Cost and Project Cost Management? Cost is A resource sacrificed to achieve a specific objective or something given up in exchange 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 Dr. Feng-Jen Yang 5

6 Project Cost Management Processes Estimating costs Develop an approximation or estimate of the costs of the resources needed to complete a project Determining the budget Allocate the overall cost estimate to individual work items to establish a baseline for measuring performance Controlling costs Control changes to the project budget Dr. Feng-Jen Yang 6

7 Project Cost Management Summary Dr. Feng-Jen Yang 7

8 Basic Principles of Cost Management Most members of an executive board Have better understand in financial terms than IT terms Are more interested in financial terms than IT terms IT project managers must speak their language Profits are Revenues minus expenditures Profit margin is The ratio of profits to revenues Dr. Feng-Jen Yang 8

9 Basic Principles of Cost Management cont. Life cycle costing A big-picture view of the cost of a project though out its life cycle Consider the total cost of ownership for a project The development plus support costs The downtime cost for IT application Dr. Feng-Jen Yang 9

10 Basic Principles of Cost Management cont. Cost of Downtime for IT Applications Dr. Feng-Jen Yang 10

11 Basic Principles of Cost Management cont. Cash flow analysis determines The estimated annual costs and benefits for a project and the resulting annual cash flow Project manager must conduct cash flow analysis to determine net present value (NPV) Top manager must consider cash flow concerns when selecting project to invest Dr. Feng-Jen Yang 11

12 Basic Principles of Cost Management cont. Tangible costs or benefits Costs or benefits that are easy to measure in dollars Intangible costs or benefits Costs or benefits that are difficult to measure in dollars Direct costs Costs that can be directly related to producing the products and services of the project Dr. Feng-Jen Yang 12

13 Basic Principles of Cost Management cont. Indirect costs Costs that are not directly related to the products or services of the project But are indirectly related to performing the project Sunk cost Money that has been spent in the past When deciding what projects to invest or continue Should not include sunk costs Dr. Feng-Jen Yang 13

14 Basic Principles of Cost Management cont. Many people fall into a trap of Considering how much money has been spent on a failing project and hate to stop spending money on it This trap is similar to Gamblers not wanting to stop gambling because they have already lost money Sunk cost should be forgotten Dr. Feng-Jen Yang 14

15 Basic Principles of Cost Management cont. Learning curve theory When many items are produced repetitively The unit cost of those items decreases in a regular pattern as more units are produced Reserves Dollars included in a cost estimate to mitigate cost risk By allowing for future situations that are difficult to predict Dr. Feng-Jen Yang 15

16 Basic Principles of Cost Management cont. Contingency reserves Allow for future situations that may be partially planned for Sometimes called known unknowns Included in the project cost baseline Example An organization has a 20% IT personnel turnover rate Should include contingency reserves to pay for recruiting and training costs for IT personnel Dr. Feng-Jen Yang 16

17 Basic Principles of Cost Management cont. Management reserves Allow for future situations that are unpredictable Sometimes called unknown unknowns 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 Dr. Feng-Jen Yang 17

18 Estimating Costs Project managers must take cost estimates seriously To complete projects within budget constraints It is important to know The types of cost estimates How to prepare cost estimates Typical problems associated with IT cost estimates Dr. Feng-Jen Yang 18

19 Types of Cost Estimates Rough order of magnitude (ROM) estimate A rough estimate of what a project will cost Is done very early in a project or even before a project is officially started Referred to as a ballpark estimate or a guesstimate Help to make project selection decisions Accuracy Typically range from -50% to +100% Many IT professionals automatically double estimates for software development Dr. Feng-Jen Yang 19

20 Types of Cost Estimates cont. Budgetary estimate Used to allocate money into an organization s budget Many organizations develop budgets at least 2 years into the future Made 1 to 2 years prior to project completion Accuracy Typically range from -10% to +25% Dr. Feng-Jen Yang 20

21 Types of Cost Estimates cont. Definitive estimate An accurate estimate of project costs Used for Making many purchasing decisions Estimating final project cost Made 1 year or less prior to the project completion Dr. Feng-Jen Yang 21

22 Types of Cost Estimates cont. Example If a project will purchase 1000 PCs from an outside supplier in the next three months A definitive estimate would be required to evaluate supplier proposals and allocate the fund to pay the chosen supplier Dr. Feng-Jen Yang 22

23 Cost Management Plan A document that describes How the organization will manage cost variances on the project How to respond to proposals that are higher or lower than the estimates Some organizations assume A cost proposal within 10% of the estimate is acceptable Only negotiate items that are more than 10% higher or 20% lower than the estimated costs Dr. Feng-Jen Yang 23

24 Cost Management Plan cont. Another important consideration in preparing cost estimate is labor cost A large percentage of total project costs are often labor costs Project managers must develop and track estimates for labor Labor costs are often much higher for contractor It is important to distinguish between internal and external resources Dr. Feng-Jen Yang 24

25 Cost Estimation Tools and Techniques 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 Bottom-up estimates Estimate individual work items or activities and sum them to get a project total Parametric modeling Use project characteristics (parameters) in a mathematical model to estimate project costs Dr. Feng-Jen Yang 25

26 Typical Problems with IT Cost Estimates Estimates are done too quickly May be done before clear system requirements have been produced Lack of estimating experience People who develop estimates often don t have enough experience Human beings are biased toward underestimation Senior IT professionals or project managers might make estimates based on their own abilities and forget that many junior people will be working on a project Dr. Feng-Jen Yang 26

27 Typical Problems with IT Cost Estimates cont. Management desires accuracy Management really wants a more accurate number To help them create a bid to win a major contract or get internal funding It is important for project managers to help develop good cost estimate and use their leadership and negotiation skills to stand by those estimate Dr. Feng-Jen Yang 27

28 Sample Cost Estimate Before creating an estimate Know what it will be used for Gather as much information as possible Clarify the ground rules and assumptions for the estimate If possible Estimate costs by major WBS categories Create a cost model Make it easy to change and document the estimate Dr. Feng-Jen Yang 28

29 Sample Cost Estimate cont. Dr. Feng-Jen Yang 29

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