1. Budgeting and Cost Estimation
Budgets defined
Two major approaches
Pros and Cons
Behavioral issues
Financial issues

2. Projects Make the Best of Scarce Resources

3. Developing a Project Budget
Three major elements
Forecast what will be needed
Labor and material
How much will it cost?
When will it be needed?
Thus, the budget reflects the project plan, time-phased, in dollars

4. NASA’s Pathfinder Rover: Mars on a Shoestring

5. Why Budgeting for Projects is Tougher
By definition, projects are unique, non-recurring efforts
So there’s often little history, little tradition to rely on
Further, projects can last for years
More uncertainty, more risk

6. Potential Project Life Cycles, Figures 7-1 and 7-2

7. Two Major Approaches to Budgeting
Top-Down
Bottom-Up
Each has advantages And disadvantages as well

8. Top-Down Budgeting Based on managerial judgment, and historical data
History can include actual costs from similar projects, adjusted for differences and for inflation
Start at the top, and allocate down through the WBS

9. Pros and Cons of Top-Down Budgeting
Quick, simple
Fair accuracy overall, though individual elements may be in error
Small tasks need not be individually identified
Cons
Limited buy-in by junior managers
Senior managers views may be biased
Using data from dissimilar projects, or old projects, can mislead

10. Bottom-Up Budgeting
Starts at the bottom of the WBS, with the people who do the work
Then costs are aggregated upward
Overhead, project reserves, and profit have to be added in

11. A Format for Gathering Data on Project Resource Needs, Figure 7-3

12. Pros and Cons of Bottom-Up Budgeting
More accurate, in detailed elements
The benefits of participative management
Differences of opinion can be resolved
Cons
Overlooking a task can be a costly error
Time-consuming to prepare
Estimates can be padded at every level

13. Behavioral Issues in Budgeting
Different perspectives, based on managerial level
Senior people tend to underestimate, junior people tend to overestimate
Lower levels tend to arbitrarily add reserves, upper levels to arbitrarily delete them
Bottom Line: Any system can be gamed
So know what the games are . . .

14. Behavioral Issues in Budgeting: Emanon Aircraft Corporation
Loss of business: Problem or symptom?
Keep asking “Why?”
Emanon loses business. Why?
. . . Because bids are too high. Why?
. . . Because material estimates are inflated. Why?
. . . Because purchasing is adding its own reserve. Why?
. . . Because they were burned once, and don’t want to be burned again.

15. Financial Issues Worth Considering: Inflation
Inflation can distort estimates in different ways
Actual costs from the past will be less than comparables for today – the older the data, the greater the disparity
Long-duration projects can create special problems
Six percent inflation doubles cost in just 12 years . . .
. . . And 6% is low in much of the world

16. Financial Issues Worth Considering: Learning Rate
As output doubles, labor hours per unit decrease by a fixed percentage
For example, the first unit of output takes 1,000 hours, and the learning rate is 80%
Unit
Labor hours req’d for that unit 1
1000 2
800 4
640 8
512

17. Effects of Ignoring the Learning Curve, Figure 7-4

18. Excel® Template for Cost Estimation, Figure 7-5

19. Excel® Formulas for Figure 7-5

20. Estimation Template Using Ratios, Figure 7-7

21. Formulas for Figure 7-7

22. Case: The Stanhope Project

23. From: The Stanhope Project, Labor Buildup

24. Reading: Three Perceptions of Project Cost

25. From: Three Perceptions of Project Cost (Figure 2)

26. From: Three Perceptions of Project Cost (Figure 3)