1. Cost Management 1

2. Cost Study Standish Group (2004) study found that average IT project cost overrun was 43 percent, 71 percent of projects were over budget, over time, and under scope, and total waste was estimated at US$55 billion per year in the US alone Spectacular examples of cost overruns are the: – Suez Canal with 1,900% – Sydney Opera House with 1,400% – Concorde supersonic airplane with 1,100% – Boston's Big Dig was 275%, or US$11 billion – Channel tunnel between the UK and France was 80% for construction costs and 140% for financing costs. 2

3. Cost Overruns Three explanations of cost overrun – Technical Imperfect forecasting techniques, inadequate data, etc. – Psychological Optimism bias with forecasters – Political-economic Result of strategic misrepresentation of scope and/or budgets All of these are a form of risk 3

4. Cost Overruns As seen on the previous slides studies have found that the greatest cause of cost growth was poorly defined scope at the time that the budget was established However, a project's budgeted costs should always include cost contingency funds to cover risks (other than scope changes imposed on the project) Poor risk analysis and contingency estimating practices account for many project cost overruns 4

5. Cost Uncertainty When estimating the cost for a project, product or other item or investment, there is always uncertainty as to precise content of all items in the estimate – How work will be performed – What work conditions will be like when the project is executed These uncertainties are risks to the project – These risks are "known-unknowns" because the estimator is aware of them, and based on past experience, can even estimate their probable costs – The estimated costs of the known-unknowns is referred to by cost estimators as cost contingency 5

6. Cost Overview Costs – Resource sacrificed or foregone to achieve a specific objective – Must be paid to acquire goods & services Projects – Cost money – Consume resources that could be used elsewhere so project managers need to practice good cost management Preparing good cost estimates is important & challenging 6

7. Cost Overview Have you heard? – Time is money There’s a strong relationship between – Cost and Time management Cost, like time must be: 7 PlannedEstimated Monitored and Controlled

8. What should you know about cost? Estimates – Based on WBS are more accurate – Are provided the one doing the work – Are improved through the use of Historical information – Must reviewed and examined for risk (reasonableness) – Must be sensible throughout the project – Can be reduced by eliminating risks Don’t change the cost baseline unless approved changes requires it Manage the project to the cost baseline Don’t readily accept constraints, but determine project needs, resolve differences and develop your own estimates Calculate ETC to ensure enough funds and time are available to complete the project Padding is not an acceptable PM best practice PM must meet established estimates PM has responsibility to provide the best estimates possible 8

9. What should you know about cost? Work packages and activities are used to create cost estimates WBS is finalized by establishing control accounts Control Account – Management control point – Scope, cost and schedule are integrated and compared to the earned value for performance measurement – Placed at select points in the WBS – May include 1 or more work packages – Each work package may only be related to one control account 9

10. Cost Management Plan? Tells how cost are declared like: what currency? Tells the estimation accuracy required Suggests the report formats used Tells rules for measuring cost performance Tells what cost is a function of (or how costs are calculated) Defines – Direct costs: directly traced to the project – Indirect costs: not directly traced to a specific project – The thresholds for control? 10

11. Cost Management Plan? Answers the following questions: – How do I plan for project costs? – How do I manage to the cost baseline – How do I manage cost variances? – How do I control costs? 11

12. Project Cost Management Processes required to ensure project is completed within an approved budget Project managers must make sure their projects: – Are well defined, – Have accurate time & cost estimates – Have realistic budget that they were involved in approving 12

13. Cost Management Process Planning Process Group Estimate Costs Planning Process Group Determine Budget Monitoring and Controlling Process Group Control Costs 13

14. Estimate Costs The process where estimates for each activity are determined What needs to be estimated? – Staff wages – Contractor costs – Materials – Supplies – Equipment – Hardware – Software – Design tools, etc. 14

15. Estimate Cost Inputs Historical information – don’t reinvent the wheel Scope baseline – Work of the project – What’s excluded from the project Project schedule – Tasks, durations, resources, dependencies, what if’s Human Resource Plan – Rates, reward systems (to increase productivity) Risk Register – Tasks required to control risks Organizational Process Assets – Policies on estimating, templates, processes, LLs Enterprise Environmental Factors – Company culture – Market place conditions Project Management Costs Project Manager Team Members 15

16. Estimate Costs Tools and Techniques Most likely estimate Analogous estimate – top down Parametric estimate – A statistical relationship between historical data and other variables – If one can install 25 meters of cable/hr then 1000 meters of cable can be installed in approximately 40 hrs 3 point estimate – PERT Bottom-Up estimate – Most accurate type of estimate – Estimates are provided for the children of each work package and aggregated up to the project level 16

17. Estimate Costs Tools and Techniques PM Software – MS Project – Excel Labor Rates Reserve Analysis – Used to support cost and time risk – Identify which activities have significant risks – Determine how much money/time to reserve to manage the risk event should it occur Cost of Quality – Add the amount of cost associated with quality planning to the estimate 17

18. Estimate Costs Tools and Techniques Accuracy of Estimates – A function of one’s knowledge about the project at any given point in time Types of Cost Estimating – Rough Order of Magnitude (ROM) Estimate Usually made during initiating process; -25/+75% – Definitive Estimate Usually made later at end of planning but prior to build phase; -5/+10% 18

19. Estimate Costs Tools and Techniques Typical Problems with Cost Estimates Estimating for a large project is complex and requires significant effort – Estimates performed at various stages of the project – PMs need to explain the rationale for each estimate – Rarely are the more precise later estimates less than the earlier estimates People who develop cost estimates often don’t have much experience with cost estimation Often there is not enough accurate, reliable data available on which to base estimates People are biased toward underestimation Many key areas such as integration, test, analyze & fix are omitted 19

20. Output of Cost Estimating Activity cost estimates Basis for the estimate – how it was created – Assumptions made and known constraints – Range of possible estimates – Confidence level of the final estimate Project Document Updates – Changes or updates to the risk register – Changes to the project management plan – Changes focused on decreasing project costs 20

21. Determine Budget - Process Total cost of the project must be calculated so management knows how much to have available for it The result of this calculation is the budget The overall project estimate is not complete without considering risks associated with completing the project Project risks are accomodated by 2 types of reserves: – Contingency Reserves – Management Reserves 21

22. Determine Budget Cost Baseline – Estimate costs of individual activities or work packages that the project manager is authorized to manage and control Contingency Reserves – Address the cost impacts of the risks remaining during risk planning – Cost baseline = Cost estimate + contingency reserves Management Reserves – Money allocated to cover unforeseen risks or changes – Budget = Cost baseline + management reserves 22

23. Determine Budget – Add it Up! Activity estimates Work package estimates Control account estimates Project estimates Contingency reserves Cost baseline Management reserves Cost budget 23 $150$275$400$300$775 WP 1 $425 WP 2 $400 WP 3 $1,075 CA 1 $825 CA 2 $1,075 Project Estimate $1,900 Contingency Reserves $190 Cost Baseline $2,090 Management Reserves $104 Cost Budget $2,194

24. Determine Budget – Sanitize It! Compare your numbers to: – Parametric estimates – Expert judgment – Historical data Check cash flow – Make sure money will be available when needed Compare your numbers to the charter – Determine variances if any – Meet with management if required 24

25. Control Costs How does PM control costs? How does the PM control costs? – Follow the cost management plan Meetings on cost Develop reports to find variances Remember control means to measure Perform recurring measurement activities looking for variances and taking action where necessary – Review OPAs available – Consider corporate policies, procedures, tools – Preventing unnecessary changes and activities that cause costs to rise – Have the ownership attitude about costs and all other parts of the project – Be assertive 25

26. Control Costs – Progress Reporting Helps control the costs and schedule Helps determine if project is on track Many PMs determine progress by asking team for an estimate of %complete for each work package or activity For activities that are difficult to measure the %complete estimate may just be a waste of time Providing an good estimate requires expert judgment 26

27. Control Costs – Progress Reporting If the project has been planned using a WBS to the level of work packages that require a standard number of hours to complete and if reporting %complete is not working, there’s an alternative method of determining progress 50/50 Rule – An activity is assumed 50% complete when it begins and gets credit for the last 50% when completed 20/80 Rule – An activity is assumed 20% complete when it begins and gets credit for the last 80% when completed 0/100 Rule – An activity doesn’t get credit until it’s completed 27

28. Control Costs Earned Value Management (EVM) Used to measure project performance against the scope, schedule, and cost baselines Performance measurement baseline is the combination of the: – Scope baseline – Schedule baseline – Cost baseline Results from EV analysis show potential deviation of the project from the performance measurement baseline Many PMs manage by comparing planned to actual, but this method may reveal schedule variances and miss cost variances EV integrates cost, schedule and scope and may be used to forecast future performance and completion dates and costs 28

29. Control Costs Earned Value Management - Terms Short NameTermMeaning PVPlanned ValueStarting today, what is the estimated value of the work planned to be done? EVEarned ValueStarting today, what is the estimated value of the work actually accomplished? ACActual CostStarting today, what is the actual cost incurred for the work accomplished? BACBudget at Completion (the budget) How much did we budget for the total project effort? EACEstimate at CompletionWhat do we currently expect the total project to cost (a forecast) ETCEstimate to CompleteFrom now, how much more do we expect it to cost to finish the project? (a forecast) VACVariance at CompletionStarting today, how much over or under do we expect to be at the end of the project? 29

30. Control Costs Earned Value Management - Terms TermFormulaMeaning PV – Planned ValueWork package 1 + Wp2 + WpN Total work in work packages or control account under evaluation EV – Earned ValueBAC * %Complete PV cumulative* %Complete %Complete of planned work CV – Cost VarianceEV - AC<0 = Over budget >0 = Under budget SV – Schedule VarianceEV - PV<0 = Behind schedule >0 = Ahead of schedule CPI – Cost Performance Index EV AC 1 good For each $1 spent we are getting $__ worth of work SPI – Schedule Performance Index EV PV 1 good We are moving at __% of the rate planned 30

31. Control Costs Earned Value Management - Terms TermFormulaMeaning Estimate at Completion 4 variations based on assumptions Starting today, how much do we expect the total project to cost? Estimate at Completion - 1 AC + remaining work estimated by team Actual + new estimate for remaining work. Used when the original estimate was wrong. Estimate at Completion - 2 BAC CPI Used if no variances from the BAC have occurred or the project will experience the same rate of spending Estimate at Completion - 3 AC + (BAC – EV)Actual to date + remaining budget. Used when current variances are thought to be different from the future. Basically it’s AC + remaining value of the work to complete. Estimate at Completion - 4 AC + (BAC – EV) / (CPI * SPI)Actual to date + remaining budget modified by performance. Used when current variances are expected to be the same as the future. It assumes poor cost performance and a need to hit a firm completion date. 31

32. Control Costs Earned Value Management - Terms TermFormulaMeaning TCPI – To Complete Performance Index (BAC – EV) (BAC – AC) Remaining work Remaining $$ Good if <1 Divides the remaining work to do by the money remaining to do it. What rate must be met for the remaining work in order to stay within budget? ETC – Estimate to Complete EAC - ACHow much more will the project cost? This is a re-estimation of the remaining work from the bottom up. VAC – Variance at Completion BAC - EACHow much over or under budget will we be at the end of the project? 32

33. Control Costs Earned Value Management - Terms Old TermNew TermNew Short Name Budgeted Cost of Work ScheduledPlanned ValuePV Budgeted Cost of Work PerformedEarned ValueEV Actual Cost of Work PerformedActual CostAC 33

34. Control Costs Earned Value Management Scenarios Don’t be afraid of Earned Value Earned value is a useful tool for measuring project performance and determining the need to request change 34

35. Control Costs Earned Value Management Scenarios 1.CPI of 1.5 says for every $1.00 spent on the project we are receiving $1.50 of value 2.SPI of.75 says the project is progressing at 75% of the rate we expected Assuming both 1 and 2 above are true what are some of the alternatives that the PM may want to consider? 35

36. Control Costs Earned Value Management Problems Problem: The CPI and SPI can be graphed frequently to show project movement or trends. Base on the diagram, if you just took this project over from another PM, what would you be apprehensive about? Graph: 36

37. Solution As you can see these calculations were made in the past and the information is historical. The most current measurement was in Dec-09 and both indexes are > 1 or good. Therefore, the best answer is, to be most worried about schedule. Starting today, the SPI is the lowest. A rule of thumb in interpreting performance index questions that ask you to determine whether cost or schedule worries you the most is to ask yourself, “Self, which index is the lowest?” 37

38. Control Costs Earned Value Management Scenarios Your have to paint the walls of the shed in the back yard. The shed is a room with 4 walls. Each wall requires 1 day to paint and is budgeted for $200 per wall. The walls are planned to be completed one after the other. Today is the end of day 3. Using the following project milestone chart, calculate PV, EV and other values listed in the spaces provided. Explain the meaning of your answers. 38

39. Control Costs Earned Value Management Scenarios ActivityDay 1Day 2Day 3 Status EOD 3 Side 1 AS-----------AF 100% Complete Spent $200 Side 2 AS-----------PF 100% Complete Spent $240 Side 3 PS----AS----PF 50% Complete Spent $120 Side 4 PS------------PF Didn’t start KeyAS=Actual StartAF=Actual FinishPS=Planned StartPF=Planned Finish 39

40. 40 Paint the Walls of the Shed BAC = $800 Planned Value at the end of the 3 rd day is $600

41. Paint the Shed Worksheet What is?WorkSolutionMeaning PV EV AC BAC CV CPI SV SPI EAC ETC VAC 41

42. 42 What is?FormulaResultMeaning Planned ValueThe sum of the planned value for the 1st 3 days $600.00The plan was to complete $600 worth of work Earned ValueThe sum of the earned value for the 1st 3 days $500.00Only completed $500 worth of work Actual CostThe sum of the actual cost for the 1st 3 days$560.00Actually spent $560 Budget at CompletionThe sum of the planned value for all 4 days$800.00The project budget was $800 Cost VarianceEV - AC($60.00)Over budget by $60 Cost Performance IndexEV / AC$0.89For each $1 spent only getting $.89 of value is received Schedule VarianceEV - PV($100.00)The project is behind schedule Schedule Performance IndexEV / PV$0.83The project is moving at 83% of the expected rate Estimate at CompletionBAC / CPI$896.00Used if no variances from the BAC have occurred or the project will experience the same rate of spending noted in a recent trend Estimate to CompleteEAC - AC$336.00Cost to complete the project Variance at CompletionBAC - EAC($96.00)Variance between planned and actual cost at the end of the project.

43. Control Costs: Problem What is CV? Problem: Your project has a Green Light. In the latest performance measurement reporting, you notice that the CPI is 1.25, the SPI is 1.10, the PV is $118,500. However, you can’t seem to find the CV in the report, so you need to calculate it based on the information available. What is CV? 43

44. Control Costs: Solution Steps What is CV? Problem Approach: Here’s what you know %Complete = Tasks completed / Tasks Planned EV = PV * %Complete CV = EV - AC SV = EV - PV CPI = EV / AC SPI = EV / PV 44

45. Control Costs: Solution Steps What is CV? What are we solving for? Answer: CV CV = EV – AC, we need EV and AC SPI = EV/PV SPI = 1.1 ; PV = $118,500 ; 1.1 = EV/118,500 1.1 * $118,500 = EV/$118,500 * $118,500 EV = 1.1 * $118,500 ; EV = $130,350 CPI = EV/AC ; 1.25 = $130,350/AC ; 1.25AC = $130,350 1.25AC = $130,350 ; AC = 1.25/$130,350 ; AC = $104,280 1.25 1.25 CV = EV – AC, CV = $130,350 - $104,280, CV = $26,070 CV = $26,070 Control Cost results in change requests, recommended corrective and/or preventive actions, and updates to the project management plan and project documents 45