9.3 Estimating Costs and Determining Budget

As detailed in Chapter 2, financial indicators are commonly utilized in business cases and their accompanying benefits management plan while selecting projects to continue with. Whereas financial indicators such as profitability, NPV (Net Present Value), and payback period are helpful in the selection process to understand the economic feasibility of the projects, we should emphasize again that there are multiple criteria besides financial indicators. During this selection process and when the project is conceptualized to create a project charter, business analysts and project managers usually don’t have an adequate amount of information to estimate an accurate cost. Therefore, estimation techniques such as expert judgment and analogous estimating could be more helpful during the earlier stages. Expert judgment of experienced managers can help make more accurate estimates with less detailed information. Estimates in the earliest stages also include information from previous projects (i.e., analogous estimating) that can be adjusted and scaled to match the size and complexity of the current project. Besides standardized formulas can be used (parametric estimating). When we make an estimate early in the project without knowing much about it, that estimate is called a rough order-of-magnitude estimate (or a ballpark estimate). This estimate will become more refined as time goes on and we learn more about the project. In a later stage, the planning phase, when we develop the WBS and activity list, bottom-up estimating accompanied by three-point estimates can generate cost estimates with better accuracy.

The goal of estimating costs is to determine the monetary resources required for the project[i] ^[1]. In order to estimate costs for individual activities and the overall project, as explained above, we can use the techniques that we utilized to estimate schedule and resources. In this textbook, we will describe five tools and techniques for estimating costs.

9.3.1       Expert Judgment

As discussed in Chapters 7 and 8, the project team consults domain and implementation subject matter experts who have technical knowledge and experience in the areas the project activities are related. These experts are those who worked on previous similar projects, and/or those who have information in the industry, discipline, and application area^[2]. Experts in organizations’ finance, accounting, and procurement departments are usually consulted. All these experts can be consulted during the pre-project work^[3], and also during the initiating and planning.

9.3.2       Analogous estimating

As discussed in Chapters 7 and 8, information and lessons learned from previous projects, standards provided by the regulatory agencies, government organizations, and occupational associations, and the data that rely on articles, books, journals, and periodicals can be utilized to estimate costs. If a similar project cost a certain amount, then it can be reasonable to assume that the current project will cost about the same. However, many factors need to be taken into account since simply copying the costs from previous projects and pasting them on the new project’s cost tables wouldn’t work for most of the projects. Few projects have the same size and complexity. Therefore, estimates must be adjusted upward or downward to account for the differences. Inflation and currency rates as well as socio-economic conditions are important indicators that would entail an adjustment. The selection of projects that are similar and the amount of adjustment needed is up to the judgment of the person or the team who makes the estimate. It should include the lessons learned from previous projects, both at an organizational level and individual level. Therefore, this judgment is based on many years of experience comprised of successful and unsuccessful projects and their estimates.

9.3.3       Parametric estimating

As explained in Chapter 7, in this estimation technique, we can use equations and algorithms to calculate the costs. This method is quantitative. Estimates are calculated by multiplying measured parameters by cost-per-unit values. If the project consists of activities that are common to many other projects, average costs are available per unit. For example, if we ask a construction company how much it would cost to build a standard office building, they will ask for the size of the building in square feet and the city in which the building will be built. From these two factors—size and location—the company’s estimator can predict the cost of the building. Factors like size and location are parameters—measurable factors that can be used in an equation to calculate a result. The estimator knows the average cost per square foot of a typical office building and adjustments for local labor costs. Other parameters such as quality of finishes are used to further refine the estimate. Readers can visit Cost To Build’s website https://www.costtobuild.net/calculator.html to estimate the cost of their dream houses and garages. In Chapter 7, for Grocery LLC’s m-commerce project, we calculated the time software developers need to create 200 lines of code for a module. Based on the previous projects and the feedback we received from the subject matter experts, we have estimated that a developer can finish 40 lines in an hour, and hence 200 lines in 5 hours. We also added a one-hour break and a two-hour review for this task. Therefore, the total work hours amounted to 8 hours. If the average hourly rate of a software developer is $50, for this activity, we will pay $400 ($50 x 8 hours). Project managers can also prefer deducting one hour of break time. This technique can produce higher levels of accuracy depending on the sophistication and underlying data built into the model. Parametric estimates can be applied to the whole project or segments of it, in conjunction with other estimating methods^[4].

9.3.4       Three-point estimating

As is done for activity duration estimates (see Chapter 7), cost estimates can be also done based on three scenarios:

1. A realistic estimate (most likely to occur – m)
2. An optimistic estimate (best-case scenario – o)
3. A pessimistic estimate (worst-case scenario – p)

Please refer to the exercise inside the “7.3 Estimating Activity Durations” sections in Chapter 7. Furthermore, three-point estimating is detailed in “9.3.1 Case Study 9.1: Estimating the Cost for M-Commerce Project’s Scope Component”.

9.3.5       Bottom-up estimating

As discussed in Chapters 7 and 8, we decompose our project activities through WBS by breaking down complex activities into pieces – work packages. Cost estimation can be made more accurately after each activity duration is estimated, and the resources required for each activity are identified. It is a process of estimating individual activity costs and then adding these together to come up with a total estimate. It takes a considerable amount of time to perform bottom-up estimating because every activity must be assessed and estimated accurately to be included in the bottom-up calculation. The smaller and more detailed the activity, the greater the accuracy and cost of this technique. Parametric estimating and three-point estimating are commonly utilized together with bottom-up estimating.

9.3.6       Case Study 9.1: Estimating the Cost for M-Commerce Project’s Scope Component

Let’s continue with our example in Chapter 8. Table 9.1 is the revised resource usage calendar (Table 8.3) after resources are leveled.

Table 9.1: Resource Usage Calendar after Resource Leveling

To conduct a parametric estimating, we should know the hourly rates of these four human resources. In this example, we assume that we only use these resources, and they work full-time in project activities. Their hourly rates are given in Table 9.2 below. Besides these four human resources, we have the project manager who is always involved in all project activities to coordinate them and ensure that all of them are smoothly performed and completed. Therefore, we won’t assign an hourly rate to the project manager, but a weekly rate of $2,000. The duration of “Scope” is 6 weeks. Therefore, the cost of the project manager is $12,000 for the “Scope”.

Table 9.2: Hourly Rates of Four Team Members

As can be seen in Table 9.2, parametric estimating has been used to calculate the total costs for the scope. For instance, systems analyst 1 will be paid $5,040 which is the result of a multiplication of $30 by 168 hours. We also added the project manager’s six-week cost making the total cost for the “Scope” $23,920.

Table 9.3 details the costs by activity. As can be seen in this table, work packages under 1.3 are added to compute the total cost of 1.3, and all the activities are added to compute the total cost of the “Scope”.

Table 9.3: Bottom-Up Estimating for the “Scope”

Let’s also assume that, first, we utilized a three-point estimation for the activities of 1.3 in the initiation phase, as seen in Table 9.4, but then we had details of each activity (e.g., requirements to be met, hours that team members should work to finish the activities) and recruited the people by signing contracts. Table 9.4 shows the three-point estimation in a beta distribution. The calculation below is for activity 1.3.1. After all the costs are estimated, we can add all of them to compute the total cost of 1.3 (Bottom-up estimating).

Beta distribution:

Table 9.4: Three-Point Estimating for 1.3 of the “Scope”

Project management software such as Microsoft Project will often have features designed to help project managers estimate resource needs and constraints, and accordingly compute the costs for each activity and the overall project. Please see 9.6 “Microsoft Project Tutorials”.