Cost Estimation - How to get it right every time?
As the founder of the Project Management Research Institute which is a not-for-profit organization focusing on project management research, development, consulting and training, I have been training people for many years on the principles of effective project management. One of the areas I see is a challenge for almost all the people, is in planning the project and in knowing how to estimate costs accurately and efficiently.
First there is a dearth of knowledge on how to actually carry out the estimation, then there is a lack of ability in how to apply or implement those estimates usefully – both these together are the key to successful project lifecycles.
After getting to know WRENCH and Daniel, I am delighted to see that technology dedicated to project management has finally stepped up to solve problems which have daunted project managers for decades. I hope more companies realise that software is their friend, and can help them achieve their goals in project management. Why do I say this? Because I have seen firsthand how companies struggle to accurately estimate so many aspects of project planning. I will talk more on these later.
Starting with the first part – how to estimate project cost.
What is Project Cost Estimation?
Project Estimation are of two types. Cost / Effort estimation and project duration estimation. The work breakdown structure provides us with the breakup of work, but at the same time does not provide us with the sequence in which the work has to be performed. Hence, work breakdown structures are good enough to perform cost estimation. For example, In IT projects, since the major contributor to cost is the manpower cost, the terms cost and effort are used and they both point to the cost estimate, while in other domains like civil, electrical, mechanical etc the project cost includes manpower, material and equipment costs.
Project estimation in all projects happens during pre-sales (early) stage and during detailed project planning. During the early stages of project, we have to arrive at the cost estimates using the WBS, as task level details will not be available. Wide band delphi technique, along with the three-point estimation technique is the most widely used techniques for early project estimation.
The Three Point Estimate Method
How to use the Three-point estimate method: For every work package, three estimates are derived, namely, Optimistic (O) which is the most aggressive, Pessimistic (P) which is the most generous, and Most Likely (M), which is the most probable.
We then use the formula (O+4M+P)/6 to arrive at single point estimate.
For example, let’s say you are traveling from Point A to Point B.
Optimistic estimate is 1 hour
Pessimistic estimate is 3 hours
Most likely estimate is 2 hours
Then the single point estimate is (1+4×2+3)/6 = 12/6 = 2 hours
The Delphi Technique
Named after the ancient Delphi Oracles who, it is said, could predict the future, the modern Delphi Technique is a method of project forecasting based on the notion that a structured group of experts is more likely to forecast accurately than an unstructured group.
How is the Delphi technique is used in project estimation? Typically, this is what happens in a project: the work packages to be estimated are explained to a group of experts who have the required domain knowledge. These experts derive the optimistic, pessimistic and most likely estimates without discussing among themselves, and after the estimation they explain their individual estimates to the rest of the estimation team. The estimation team then converges that data into one set of optimistic, pessimistic and most likely values based on mutual consensus. (Averages and voting are not allowed as the estimates from the minorities can be right.) From the agreed upon three-point estimates, a single point estimate is arrived
These steps get repeated for each and every work packages of the projects, and the sum total of the estimates of all the individual work packages is the project’s cost estimate.
So, we have understood how to do this in theory. Why do we need technology?
Why we need IT
The challenge as you can imagine is quite pervasive; in a manually-managed environment, getting consensus of any kind of difficult, let alone something as complex as project costs.
Firstly, the amount of data required to accurately estimate is not always available so the company ends up more ‘guesstimating’ than estimating. One small inaccuracy can throw off an entire estimate and have the dreaded ripple effect, ultimately ending up in some kind of delay as the project progresses. Secondly, in verticals where the churn rate is quite high, it is not always easy to have experts on board who have the necessary experience and knowledge needed to use that data wisely or effectively.
So where technology can transform the whole approach of cost estimating is because it solves both these challenges. It helps in gathering all the required data, and it also helps the company rely less on expert individuals and more on the corporate bank of knowledge and expertise of their past projects.
This ready access to all the correct data and ability to reuse knowledge is what makes today’s information technology solutions so critical for today’s projects to succeed – especially smart IT. Without IT, EPC companies will continue to be at the mercy of human ingenuity and human effort, which also makes them of course vulnerable to human faults and human error. The sad thing is, in today’s mega projects, one small human error can have disastrous consequences that are very expensive. Hence, training people on how to estimate correctly is one part of the solution, and getting the right tools to do so is the other.
In the coming weeks I will talk more on how IT can help implement project management principles and techniques more effectively. See you soon!
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