EP 702 Unit 7

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EP 702Unit 7

• Cost Management

Dr. J. Michael Bennett, P. Eng., PMP UNENE,
McMaster University, The University of Western
Ontario Version 2K6-X-10
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Revisions

• 2K6-X-10 Initial Creation

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EP 704 Road Map

• Unit 1 Introduction to Project Management
• Unit 2 The Project Management Context
• Unit 3 Project Management Processes
• Unit 4 Project Integration Management
• Unit 5 Project Scope Management
• Unit 6 Project Time Management
• Unit 7 Project Cost Management
• Unit 8 Project Quality Management
• Unit 9 Project Human Resource Management
• Unit 10 Project Communications Management
• Unit 11 Project Risk Management
• Unit 12 Project Procurement Management

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Unit 7

• Includes all of the processes necessary to plan,
  estimate, budget and control costs
• Normally this is one area in which the Org excels
• Main Areas are
• 7.1 Cost Estimating
• 7.2 Cost Budgeting
• 7.3 Cost Control
• 7.4 MCCP
• 7.5 Productivity Measures
• 7.6 Cost Overrun Causes

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PCM

• Primarily concerned with the cost of resources
  necessary to get the work done.
• Note that 6 and 7 are often combined as a single
  activity.
• Can also consider the effect of changes on the
  final product (life cycle costing or TCO).
• Note that the Cost Management Plan flows out of
  the PMP development (again iterated elaboration)

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Cost Management Plan

• Precision Level of data (rounding for example)
• Units of measure
• Org Procedures linkages
• Control Thresholds
• Earned Value Rules
• Reporting Formats
• Process Descriptions

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History, Org Policies
Marketplace conditions Commercial databases
Project Scope Stmt
Project Management Plan
Cost Management Plan
Approved Change Reqs
WBS Dictionary
Activity Cost Estimates detail
Contract
CMP updates Requested Changes
Requested Changes, CMP UPs
Resource Calendar
Cost baseline Project funding reqs
Proj Schedule
Performance Reports
PMP UDs, Requested Changes
Work Performance Information
Cost Est UDs, Perf Measurements, Forecasted
Completion
OPA updates
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PMI Project Cost Management
7.1 Cost Estimation .1 Inputs .1 EEF .2
OPA . 3 Scope Statement .4 WBS .5
WBS Dictionary .6 PMP .2 Tools and
Techniques .1 Analogous Estimating .2
Determine resource cost rate .3 Bottom-up
Estimating .4 Parametric Estimating .5
PMP Software .6 Vendor Bid Analysis .7
Reserve Analysis .8 Cost of Quality .3
Output . 1 Activity Cost Estimates
.2 ACE Supporting Detail . 3 Requested
Changes .4 Cost Man Plans UDs
7.3 Cost Control .1 Inputs .1 Cost Baseline
.2 Project Funding Requirements .3
Performance Reports .4 Work Performance
Information .5 Approved Change Requests
.6 PMP .2 Tools and Techniques . 1 Cost CCS
.2 Performance Measurement Ana .3
Forecasting .4 Project Performance Reviews
.5 PM Software .6 Variance Management .3
Output .1 Cost Estimates (UDs) .2
Cost Baseline (UDs) .3 Performance
Measurements .4 Forecasted Completion
.5 Requested Changes .6 Recommended
Corrective Actions .7 OPAs (UDs0 .8 PMP
(UDs)
7.2 Cost Budgeting .1 Inputs .1 Scope
Statement .2 WBS .3 WBD Dictionary
.4 ACEs .5 ACE Supporting Detail .6
Project Schedule .7 Resource Calendars
.8 Contract .9 Cost Management Plan .2 Tools
and Techniques .1 Cost Aggregation .2
Reserve Analysis .3 Parametric Estimating
.4 Funding Limit Reconciliation .3 Output
.1 Cost Baseline .2 Project Funding
Requirements .3 CMP (Updates) .4
Requested Changes
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7.1 Cost Estimating
1 Analogous Esting 2 Resource Cost Rate 3
Bottom-up Esting 4 Parametric Esting 5 PMP
Software 6 Vendor Bid Analysis 7 Reserve
Analysis 8 Cost of Quality

1 EEF 2 OPA 3 Scope Statement 4 WBS 5 WBS
Dictionary 6 PMP
1 Activity Cost Ests 2 Supporting Detail 3
Requested Changes 4 Cost Man Plans uds

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7.1.1 Inputs to Cost Estimating

• 1 EEF
• 2 OPA
• 3 Scope Statement
• 4 WBS
• 5 WBS Dictionary
• 6 PMP

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1 EEF

• CEP considers
• Marketplace Conditions
• Commercial Databases

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2 OPA

• Cost Estimating Policies
• Cost Estimation templates
• Historical Information
• Project Files
• Project Team Knowledge
• Lessons Learned

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3 Scope Statement

• This hones the budget process
• A normal constraint is the fixed budget
• Assumptions may lead to legal ramifications

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6 Schedule Management Plan

• Need this to cost out activities appropriately
• May have to worry about the cost of financing
• Materials may have seasonal cost variations
• Same with human resource costing (cf Alberta
  right now)

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Cost Management

• Three main processes will occur at least once in
  EACH phase
• Note the better approach of using Life Cycle
  Costing (aka TCO)
• Need to separate controllable and
  non-controllable costs if a reward system is in
  place
• Example of overtime costs

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Smallies

• Resource planning, cost estimating and cost
  budgeting are often combined on small projects
  (they are so tightly integrated)

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General Comments

• Ability to influence cost is highest earliest in
  the project
• Need scope and requirements done first and ASAP!

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Assumptions

• The 10 economy! If we had 0 for the 3 years, we
  would have made 100K on our investment or 20
• The assumed income projections. Where did they
  come from and how realistic are they?

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7.1.2 TT for Cost Estimating

• 1 Analogous Estimating
• 2 Resource Cost Rate
• 3 Bottom-up Estimating
• 4 Parametric Estimating
• 5 PMP Software
• 6 Vendor Bid Analysis
• 7 Reserve Analysis
• 8 Cost of Quality

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1 Analogous Estimating

• Also called top-down
• Compare against a similar project
• Is another form of Expert Judgment
• Used when we have little information to work
  with, normally at the beginning of the project
• Least costly of the 5 methods but least accurate
• Most accurate when the projects really are
  similar and/or people really are experts

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Comparison (after Kerzner).
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Internal Rate of Return (IRR)

• What is the nominal percentage that this
  investment will return?
• Find the interest rate at which the
  NPVProjectCost
• Can be done with Excel and iteration
• Not so common now

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Return on Investment (ROI)

• measure of the efficiency of the investment
• calculated as(total benefits - total costs) x
  100 / total costs

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Growing Importance of ROIIW 2001-VIII-08, survey
of 200 IT Professionals
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Measuring PaybackIW 2001-VIII-08, survey of 200
IT Professionals
Q Does your company have formal ROI or informal
payback scenarios?
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ROI vs. IntangiblesIW 2001-VIII-08, survey of
200 IT Professionals
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Is ROI Targeted?IW 2001-VIII-08, survey of 200
IT Professionals
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Breakeven-Payback

• date when cumulative benefit flow exceeds
  cumulative costs flow
• normally expressed in months

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Traditional Cost Reduction Approaches

• Cost displacement - cost avoidance
• Work Value Analysis
• Cost of quality

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Cost Displacement - Cost Avoidance

• compares the cost for the proposed system against
  the replaced one
• most common way to justify IT projects
• used for CPUs for years

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Work Value Analysis

• permits white collar workers to do more
  profitable work
• increases efficiency of doing same work
• permits higher valued work to be done
• Sassone estimates 15 can be saved by such
  recalibration and increase of intellectual
  specialization

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2 Determine Resource Cost Rate

• Must know the unit cost rates (staff cost per
  hour, FPPM, cost per cubic meter etc)
• Get quotes from vendors
• Normally for stock items, there are standard
  rates plus inflation factors.
• Can use commercial sources
• If not, you must estimate and justify the
  estimates

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3 Bottom Up Estimating

• Start at the bottom of the WBS and roll up
• Normally we can estimate very accurately in the
  small
• Assumes that we have done sufficient breakdown so
  that we can so estimate

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2 Parametric Estimating

• Uses a mathematical (arithmetical?) model to
  estimate
• FPs are a PE method
• Works best when the method has been used for a
  long time (construction)
• Great if the model is scalable

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6 Vendor Bid Analysis

• Check out the various bids. Are they consistent?
• If we are bidding and get a contract, may have to
  do additional work to justify the final project
  cost.

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7 Reserve Analysis

• Many cost estimators add in the reserve (or
  contingency fund) as part of the project cost
  which of course make it higher.
• This is the known unknown (risks anticipated but
  not known for certain).
• Sometimes, all of the K-Us are aggregated into a
  single activity item with zero time duration.

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8 Cost of Quality

• Based on observation that organizational
  resources can be split into value-added
  services and cost-of-quality activities.
• CoQ include costs associated with LACK of quality
• Reducing quality costs can save a bundle. Good
  justifier!

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7.1.3 Cost Estimating Outputs

• 1 Activity Cost Estimates
• 2 Activity Cost Supporting Detail
• 3 Requested Changes
• 4 Cost Management Plans updates

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1 Activity Cost Estimates

• A quantitative assessment of the likely costs of
  the resources to complete the work activity
• Can be in summary or detailed form
• Can include
• Labour
• Materials
• Equipment
• Services
• Facilities
• IT
• Inflation allowance
• Contingency reserve

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2 Activity Cost Supporting Detail

• Catch-all to include all information necessary to
  understand, the costing of the scheduled activity
• Description of the activitys scope of work
• Documentation of how the estimate was developed
• Documentation of all assumptions made
• Documentation of all constraints
• Indication of the range of the estimates ()

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7.2 Cost Budgeting

• Involves aggregating the estimated costs of all
  the work packages to establish a cost baseline.
• The Scope Statement provides the summary budget.
• But these are necessary before detailed budget
  requests and work authorization can occur.

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7.2 Cost Budgeting
1 Scope Statement 2 WBS 3 WBD Dictionary 4 ACEs 5
Supping Detail 6 Project Schedule 7 Res
Calendars 8 Contract 9 Cost Man Plan
1 Cost Aggregn 2 Reserve Analysis 3 Parametric
Estg 4 Funding Limit Reconciliation
1 Cost Baseline 2 Project Funding Rs 3 CMP
(Updates) 4 Requested Changes

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7.2.1 Cost Budgeting Inputs

• 1 Scope Statement
• 2 WBS
• 3 WBD Dictionary
• 4 ACEs
• 5 ACE Supporting Detail
• 6 Project Schedule
• 7 Resource Calendars
• 8 Contract
• 9 Cost Man Plan

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7.2.2 Cost Budgeting Tools Techniques

• 1 Cost Aggregation
• 2 Reserve Analysis
• 3 Parametric Estimating
• 4 Funding Limit Reconciliation

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.5 Methods of Costing

• 5.1 Time-based Measures
• 5.2 New Strategic (non-) Initiatives

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Time-based Cost Approaches

• Net Present Value (NPV)
• Internal Rate-of-Return (IRR)
• Return on Investment (ROI)
• Breakeven/Payback

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Net Present Value

• the value today of a future payment discounted at
  an assumed rate
• if that rate is positive, will make money
• also called the Discounted Cash Flow

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NPV Example

• We will make 100K in a year
• That amount today must be discounted by 10
• For example, if we invested 100K at 10, in a
  year it would be worth 110K
• Therefore the NPV of 100K in a year at 10 is
  100,000/(10.1) 90,909.
• The NPV of 100K in 2 years at 10 is
  100,000/(10.1)2 84,645.

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NPV Example

• Suppose that a project will cost 500K and take a
  year to build
• In years 2,3 and 4, it will return 100K, 200K and
  300K
• Assume a 10 economy (that is, the cost of living
  is estimated to be 10 per year)
• Question should we do the project?

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Example cont

• NPV 100000/1.1 200000/(1.1)2 300000/(1.1)3
  909,090 165,289 225,394 481,593
• Project costs 500K and will only earn 482K
• CAN IT

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.5.2 New Strategic (non-) Approaches

• Options Values
• Technological Values
• Business Objectives
• Competitive Advantage
• Research and Development

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Options Values

• assigns values to options
• think of it as a tree of decisions
• very hard to do but necessary for long-termed
  decisions such as data bases, communications,
  etc.
• OV are rejected by NPV approaches

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Technological Values

• needed to provide infrastructure
• hard to justify economic payback but mandatory
  for survival
• installation of a LAN, for example
• WAN for decentralization
• e.g..., installing fiber-optics backbone for
  client-server Business Line

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Business Objectives

• justifying IT expenditure against business
  alignment (as we have seen)

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Competitive Advantages

• Can the project build in switching costs?
• Can the project change the basis of competition?
• Can the project change the balance of power in
  supplier relationships?
• Can the project generate new products?
• Can we do it cheaper?
• Can we delight our clients?

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Examples

• Canada Trust
• Bell Mobility

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Competitive Advantages cont.

• Some suggestions for positioning the project for
  competitive advantage
• target the project to core business drivers
• examine core drivers from the customers
  perspective
• look for advantage to come from infrastructure
  initiatives rather than individual Business Lines
• assess options in terms of the time for an
  opportunity to become a necessity

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7.2.3 Outputs from Cost Estimating

• 1 Cost estimates
• 2 Supporting detail
• 3 Cost management plan

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1 Cost Estimates

• are quantitative estimates normally expressed in
  
• Every cost must be estimated
• If there are guidelines, follow them

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Classes of Estimates (after Kerzner)
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Classes of Estimates (AACE)
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1 Cost Aggregation

• These begin at the WP level and are rolled up to
  higher levels of the WBS to be assigned to
  Control Accounts (and ultimately for the whole
  project)

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.7 Chart of Accounts

• Coding structure by which we group expenses
• Can be per phase
• Per step of development process
• will be defined by the bean counters but VIP

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2 Reserve Analysis

• Must calculate the management reserves (for
  unknown unknowns).
• Not part of the project cost baseline but are
  included in the budget.
• Not used for EV calculations.
• PM must get approval to apply these from the PHB.

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3 Parametric Estimating

• Used to build a mathematical model
• Simple cost per square meter for house
  construction
• Complex software model that used 13 factors, 5
  sub factors for each)
• Most likely reliable is
• Historical data is accurate
• Parameters are reliably quantifiable
• Model can be scaled (look out!)

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4 Funding Limit Reconciliation

• A Quandary
• You do not want to allocate all the resources
  (waterfall)
• BUUUT, you want to allocate smoothly so that the
  work will not be stalled.
• FLR tries to find the optimal solution here.

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7.2.3 Cost Budgeting Outputs

• 1 Cost Baseline
• 2 Project Funding Requirements
• 3 CMP (Updates)
• 4 Requested Changes

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1 Cost Baseline

• The time-phased budget that is used for EV
  control
• Normally S-based curve
• Can have many sub cost baselines in large
  projects (for contractors, etc)

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Risks

• Need to consider risks at this point too
• Risks can have a significant impact of cost if
  they raise their hydra heads

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2 Project Funding Requirements

• These flow from the Cost Baseline in an orderly
  fashion, to ensure enough money is available to
  continue the work

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Committed versus Spent (typical)Visualizing PM
Forsberg et al
Funding Requirements
85
70
04
10
40
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7.3 Cost Control
1 Cost Ests (UDs) 2 Cost BL (UDs) 3 Perf
Meass 4 Forecast Finish 5 Reqd Changes 6 Recd
Corr Actions 7 OPAs (UDs) 8 PMP (UDs)
1 Cost CCS 2 Perf Meas Ana 3 Forecasting 4 Proj
Perf Revs 5 PM Software 6 Variance Man
1 Cost Baseline 2 Proj Funding Reqs 3 Performance
Reports 4 Work Perf. Info. 5 Approved CRs 6 PMP

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Purpose of Cost Control

• Influencing the factors that create changes to
  the cost baseline to make sure the changes are
  acceptable
• Determine that the cost baseline has changed
• Make the changes in a controlled manner

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Cost Control includes

• Influencing factors that can change the BL
• Ensuring requested changes are agreed on
• Managing the actual changes
• Assuring that cost overruns do not exceed
  authorized funding
• Monitoring and understanding cost variances
• Recording all changes against the BL.
• Informing all stakeholders of changes
• Acting to be sure cost overruns are contained

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Activities of Cost Control

• Monitoring the cost performance (EV)
• Ensuring that all approved changes are reported
  in the Cost Baseline
• Pre venting unauthorized, incorrect,
  inappropriate costs from being incurred
• Informing stakeholders (as appropriate) about the
  changes
• Keeping expected costs within limits

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3 Work Performance Reports

• Data collected includes at least
• Deliverables done and undone
• Costs authorized and incurred
• Estimates to complete the schedule activities
• complete of the schedule activities

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7.3.2 Cost Control Tools Techniques

• 1 Cost Change Control System
• 2 Performance Measurement Analysis
• 3 Forecasting
• 4 Project Performance Reviews
• 5 PM Software
• 6 Variance Management

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1 Cost Change Control System

• Defines the procedures under which the BL is to
  be changed (comes from CMP).
• Includes all forms, authorizations, tracking
  systems

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2 Performance Measurement Analysis

• Must collect
• PV planned value
• EV Earned value
• AC Actual Cost
• ETC Estimate to Complete
• CV Cost Variance (CVEV-AC)
• SV - Schedule Variance (SVEV-PV)
• CPI Cost Performance Index EV/AC SPIEV/PV
• Cumulative CPI (CPIC) S (EVC/ACC)

C1,N
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3 Forecasting

• Trickery trickery trickery
• ETC based on atypicals BAC-EVC
• ETC based on typicals (BAC-EVC)/CPIC
• Also use EAC ACC ETC
• Or EAC ACC (BAC EV)
• Or EAC ACC (BAC EV)/CPIC

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4 Project Performance Reviews

• Variance Analysis
• Trend Analysis
• Earned Value Technique

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5 PM Software

• This automatically tracks variance and EV

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6 Variance Management

• Describes how we will manage variances
• Note that they are larger at the beginning than
  at the end

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7.3.3 Cost Controls Outputs

• 1 Cost Estimates (UDs)
• 2 Cost Baseline (UDs)
• 3 Performance Measurements
• 4 Forecast Finish
• 5 Required Changes
• 6 Recommended Corrective Actions
• 7 OPAs (UDs)
• 8 PMP (UDs)

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7.4 Management Cost and Control System (MCCS)
Cost Data Collection and Reporting
Planning
Customer Manment Reporting
Cost Accountg
Work Auth and Release
Planning cycle
Operating Cycle
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The MCCS Planning Tool must be able to

• Plan and schedule the work
• ID metrics
• Establish direct labour budgets
• Establish overhead budgets
• ID Management Reserve

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Operational Requirements

• Measure resources consumed
• Measure status and accomplishments
• Compare metrics to projections, standards
• Provide basis for diagnosis and replanning

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MCCS Requirements

• Common framework to integrate time, cost,
  technical performance
• Ability to track important metrics
• Quick response
• Capability of end-value prediction
• Accurate, appropriate data for decision-making
• Full exception reporting with probability
  analysis
• Immediate quantitative evaluation of alternate
  solutions

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Cost Reduction Analysis
Possible Reductions

Cost of change
Project Life Cycle Phases
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Operational Issues

• Cost account codes
• Common to organization
• Should be hierarchical
• EV as we have seen

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7.5 Measuring Productivity Current Darlings

• Economic Value Added
• Activity-Based Costing
• Options Analysis
• Performance-based Budgeting

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Economic Value Added

• Measures benefit by applying productivity gains
• ROI, NPV, Break-even

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Activity-Based Costing

• Determines the cost of supplying a service
• How much should I charge for X.500?

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Performance-based Budgeting

• Set up performance metrics
• Tie budget to those goals to evaluate the
  effectiveness of the technology

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Options Analysis

• As we have seen
• Justify evolving to a client-server environment

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Ways of Measuring Profitability IW 2001-VIII-08,
survey of 200 IT Professionals
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Tracking Business Line Demands

• Whos doing what?
• Are trends developing?
• Can we measure Business Line profitability?
• Can we apportion network costs to Business Line?
• Are we making it pay?

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Do You Know Where Your BLs Are?

• Need to understand the business case first
• Then the Business Lines that drive the biz
• Then the data that the BLs need
• Then the network to support that
• Then the technology model
• Lastly, the bits and bytes

119
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Track Those Business Lines!

• Tie profitability back to Each BL
• The IT Infrastructure is the means to the end,
  NOT the end
• That end is PROFITABILITY
• Is the BL activity increasing, steady decreasing?

120
100
Need to Cost Business Lines

• Can munge up ROI
• ROI not only good for projects, but for running
  costs too
• Economic Value Added (EVA...note overloading) is
  new measure
• Note there is NO measurable proof that IT is
  correlated with profitability!!!!

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101
BL EVA (or at least TCO)

• Total Cost of Ownership is first step
• Done on PCs. Aberdeen Group found that the TCO is
  about 10K US/year!
• But you also need to know the EVA of the app.
  What does it add to the bottom line?

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102
Positives and Negatives

• SHOW ME THE MONEY
• Strassmann bah humbug
• no relationship between IT investment and
  profitability
• Brynjolffson now starting to see it as we
  understand the the economic

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TCO (LCC) for PCs (Gartner Group)
123
104
How to Increase TCO (LCC)

• Make Business Lines more complex
• Costly maintenance
• Cost of upgrades
• Lack of Internal Standards
• Hardware and software costs

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How to Lower TCO

• Standardize on a Platform
• Purchase cheaper H/W
• Provide end-user training
• Use management tools (esp app mans)

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Can Measure Software

• Get its Function Point count
• Can size the software
• Charge off costs, profits against the FP size
• Same with all IT costs

124
107
EVA (economic value added) is

• Companys net operating profit after deducting
  taxes and cost of capital
• Is the company makin er pay?

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108
(snooze time)

• Need to know the true cost of capital and how
  much capital is tied up
• Capital borrowed and equity
• loans out plus interest rate
• equity - 6 points more than prime (14 plus more
  if you are in a risky business)
• () Cost of capital is weighted average of both

126
109
Tied Up Capital

• Add up worth of buildings, computers, networks,
  etc etc etc
• If you have a 20M budget for new products, add
  that to your capital base. If it has a 5 year
  life expectancy, deduct 5M per year from capital

127
110
And the Envelope Please

• EVA Pretax-earnings - Capital x Cost-of-capital
• If it is positive, you are adding shareholder
  value BUY
• If negative, SELL

128
111
So How Are Doing, EVA-wise?
129
Network World Master Series - June 11, 1998
112
Benchmark Your Organization

• How is your spending relative to the rest of the
  world?
• Useful in making business cases

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Common Metrics

• Benefit/Cost Ratio
• ROI
• NPV
• IRR
• PM Scorecard

114
7.6 Common Cost Problems

• Poor estimating
• Out-of-sequence starting of events
• Inadequate WBS
• No Management policy on reporting/control
• Poor work definition at low levels
• PHB crashing to make the bid
• Inadequate formal planning

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Mo Probs

• Poor comparison of actuals/planned costs
• Unforeseen technical problems
• Schedule delays requiring overtime/idle time
• Unforeseen material escalation factors
• Inflation

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Cost Overrun Causes

• Proposal Phase
• Failure to understand requirements
• Unrealistic appraisal of in-house abilities
• Underestimating time requirements

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Cost Overrun Causes

• Planning Phase
• Omissions
• Inaccuracy of WBS
• Misinterpretation of information
• Use of wrong estimating techniques
• Failure to identify major cost elements
• Failure to to Risk Assessment

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Cost Overrun Causes

• Negotiation Phase
• Settling too quickly
• Procurement ceiling costs
• Negotiation team that must win

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Cost Overrun Causes

• Contractual Phase
• Contractual discrepancies
• SOW different from RFP
• Proposal team different from project team

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Cost Overrun Causes

• Design Phase
• Accepting customer requests without man approval
• Problems in customer communications
• Problems in design review meetings

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Cost Overrun Causes

• Production Phase
• Excessive material costs
• Specifications not acceptable
• Manufacturing and engineering disagreement

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Chapter Seven Cost Management

• 2000 Edition
• 7.1 Resource Planning
• 7.2 Cost Estimating
• 7.3 Cost Budgeting
• 7.4 Cost Control

• Third Edition
• 7.1 Cost Estimating
• 7.2 Cost Budgeting
• 7.3 Cost Control