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Chapter 7: Project Cost Management - Coggle Diagram
Chapter 7: Project Cost Management
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
(the additional percentage or dollar amount by which actual costs exceed estimates) ranged from 180 percent in 1994 to 43 percent in 2010
A 2011 Harvard Business Review study reported an average cost overrun of 27 percent. The most important finding was the discovery of a large number of gigantic overages or “black swans
Cost and Project Cost Management
Cost
a resource sacrificed or foregone 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
Project Cost Management Processes
Planning cost management:
determining the policies, procedures, and documentation that will be used for planning, executing, and controlling project cost.
Estimating costs:
developing an approximation or estimate of the costs of the resources needed to complete a project
Determining the budget:
allocating the overall cost estimate to individual work items to establish a baseline for measuring performance
Controlling costs
: controlling changes to the project budget
Basic Principles of Cost Management
Most members of an executive board better understand and are more interested in financial terms than IT terms , so IT project managers must speak their language
The Terms
Profits
are revenues minus expenditures
Profit margin
is the ratio of revenues to profits
Life cycle costing
considers the total cost of ownership, or development plus support costs, for a project
Cash flow analysis
determines the estimated annual costs and benefits for a project and the resulting annual cash flow
Learning curve theory
states that 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
Contingency reserves
allow for future situations that may be partially planned for (sometimes called
known unknowns
) and are included in the project cost baseline
Management reserves
allow for future situations that are unpredictable (sometimes called
unknown unknowns
)
Types of Costs and Benefits
Tangible costs
or
benefits
are those costs or benefits that an organization can easily measure in dollars
Intangible costs
or
benefits
are costs or benefits that are difficult to measure in monetary terms
Direct costs
are costs that can be directly related to producing the products and services of the project
Indirect costs
are costs that are not directly related to the products or services of the project, but are indirectly related to performing the project
Sunk cost
is money that has been spent in the past; when deciding what projects to invest in or continue, you should not include sunk costs
Planning Cost Management
The project team uses expert judgment, analytical techniques, and meetings to develop the cost management plan
A cost management plan includes:
Level of accuracy and units of measure
Organizational procedure links
Control thresholds
Rules of performance measurement
Reporting formats
Process descriptions
Estimating Costs
Project managers must take cost estimates seriously if they want to complete projects within budget constraints
It’s important to know the types of cost estimates, how to prepare cost estimates, and typical problems associated with IT cost estimates
The number and type of cost estimates vary by application area. The Association for the Advancement of Cost Engineering International identifies five types of cost estimates for construction projects: order of magnitude, conceptual, preliminary, definitive, and control
Estimates are usually done at various stages of a project and should become more accurate as time progresses
A large percentage of total project costs are often labor costs
Types of Cost Estimates
Budgetary
Definitive
Rough Order of Magnitude (ROM)
Basic tools and techniques
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:
involve estimating individual work items or activities and summing them to get a project total
Parametric modeling
uses project characteristics (parameters) in a mathematical model to estimate project costs
Typical Problems
Estimates are done too quickly
People lack estimating experience
Human beings are biased toward underestimation
Management desires accuracy
Determining the Budget
Cost budgeting involves allocating the project cost estimate to individual work items over time
The WBS is a required input to the cost budgeting process since it defines the work items
Important goal is to produce a
cost baseline
a time-phased budget that project managers use to measure and monitor cost performance
Controlling Costs
Project cost control includes
Monitoring cost performance
Ensuring that only appropriate project changes are included in a revised cost baseline
Informing project stakeholders of authorized changes to the project that will affect costs
Many organizations around the globe have problems with cost control
Earned Value Management (EVM)
EVM
is a project performance measurement technique that integrates scope, time, and cost data
Given a
baseline
(original plan plus approved changes), you can determine how well the project is meeting its goals
You must enter actual information periodically to use EVM
More and more organizations around the world are using EVM to help control project costs
Earned Value Management Terms
The planned value (PV)
, formerly called the budgeted cost of work scheduled (BCWS), also called the budget, is that portion of the approved total cost estimate planned to be spent on an activity during a given period
Actual cost (AC)
, formerly called actual cost of work performed (ACWP), is the total of direct and indirect costs incurred in accomplishing work on an activity during a given period
The
earned value (EV)
, formerly called the budgeted cost of work performed (BCWP), is an estimate of the value of the physical work actually completed
EV is based on the original planned costs for the project or activity and the rate at which the team is completing work on the project or activity to date
Rate of Performance
Rate of performance (RP)
is the ratio of actual work completed to the percentage of work planned to have been completed at any given time during the life of the project or activity
Brenda Taylor, Senior Project Manager in South Africa, suggests this term and approach for estimating earned value
Rules of Thumb for Earned Value Numbers
Negative numbers for cost and schedule variance indicate problems in those areas
CPI and SPI less than 100% indicate problems
Problems mean the project is costing more than planned (over budget) or taking longer than planned (behind schedule)
The CPI can be used to calculate the estimate a
t completion (EAC)
—an estimate of what it will cost to complete the project based on performance to date. The
budget at completion (BAC)
is the original total budget for the project
Global Issues
EVM is used worldwide, and it is particularly popular in the Middle East, South Asia, Canada, and Europe
Most countries require EVM for large defense or government projects, as shown in Figure 7-6
EVM is also used in such private-industry sectors as IT, construction, energy, and manufacturing.
However, most private companies have not yet applied EVM to their projects because management does not require it, feeling it is too complex and not cost effective
Project Portfolio Management
Many organizations collect and control an entire suite of projects or investments as one set of interrelated activities in a portfolio
Five levels for project portfolio management
Put all your projects in one database
Prioritize the projects in your database
Divide your projects into two or three budgets based on type of investment
Automate the repository
Apply modern portfolio theory, including risk-return tools that map project risk on a curve
Benefits
Schlumberger saved $3 million in one year by organizing 120 information technology projects into a portfolio
ROI of implementing portfolio management software by IT departments:
Savings of 6.5 percent of the average annual IT budget by the end of year one
Improved annual average project timeliness by 45.2 percent
Reduced IT management time spent on project status reporting by 43 percent and IT labor capitalization reporting by 55 percent
Decreased the time to achieve financial sign-off for new IT projects by 20.4 percent, or 8.4 days
Best Practice
A global survey released by Borland Software in 2006 suggests that many organizations are still at a low-level of maturity in terms of how they define project goals, allocate resources, and measure overall success of their information technology portfolios.
Some of the findings include the following:
Only 22 percent of survey respondents reported that their organization either effectively or very effectively uses a project plan for managing projects
Only 17 percent have either rigorous or very rigorous processes for project plans, which include developing a baseline and estimating schedule, cost, and business impact of projects
Only 20 percent agreed their organizations monitor portfolio progress and coordinate across inter-dependent projects
Using Software to Assist in Cost Management
Spreadsheets are a common tool for resource planning, cost estimating, cost budgeting, and cost control
Many companies use more sophisticated and centralized financial applications software for cost information
Project management software has many cost-related features, especially enterprise PM software
Portfolio management software can help reduce costs