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Chapter 5 Estimating Project Times and Costs Chapter Outline 1. Factors Influencing the Quality of Estimates A. Planning Horizon B. Project Complexity C. People D. Project Structure and Organization E. Padding Estimates F. Organization Culture G. Other Factors 2. Estimating Guidelines for Times, Costs, and Resources 3. Top-Down versus Bottom-Up Estimating 4. Methods for Estimating Project Times and Costs A. Top-Down Approaches for Estimating Project Times and Costs i. Consensus Methods ii. Ratio Methods iii. Apportion Methods iv. Function Point Methods for Software and Systems Projects v. Learning Curves B. Bottom-Up Approaches for Estimating Project Times and Costs i. Template Methods ii. Parametric Procedures Applied to Specific Tasks iii. Range Estimating C. A Hybrid: Phase Estimating 5. Level of Detail 6. Types of Costs A. Direct Costs B. Direct Project Overhead Costs C. General and Administrative (G&A) Overhead Costs 7. Refining Estimates 8. Creating a Database for Estimating 9. Mega projects: A Special Case 10. Summary 11. Key Terms 12. Review Questions 13. Exercises 14. Case 5.1: Sharp Printing, AG 15. Case 5.2: Post Graduation Adventure 16. Appendix 5.1: Learning Curves for Estimating A. Learning Curves for Estimating B. Follow-On Contract Example 17. Appendix Exercise: Norwegian Satellite Development Company Chapter Learning Objectives After reading this chapter you should be able to: LO 5-1 Understand estimating project times and costs are the foundation for project planning and control. LO 5-2 Describe guidelines for estimating time, costs, and resources. LO 5-3 Describe the methods, uses, and advantages and disadvantages of top-down and bottom-up estimating methods. LO 5-4 Distinguish different kinds of costs associated with a project. LO 5-5 Suggest a scheme for developing an estimating database for future projects. LO 5-6 Understand the challenge of estimating mega-projects and describe steps that lead to better informed decisions. LO 5-7 Define a “white elephant” in project management and provide examples. Appendix 5.1 Learning Objective After reading this chapter students should be able to: LO A5-1 Use learning curves to improve task estimates. Review Questions 1. Why are accurate estimates critical to effective project management? Without accurate time and cost estimates project control is ineffective. Inaccurate estimates can make the difference between profit and loss. Time and cost estimates are major inputs to project planning. Project control is completely dependent on accuracy of estimates. Estimates are needed to support good decisions. Estimates are used to determine project duration and cost. Estimates are used to develop cash flow needs. Estimates are used to develop time-phased budgets and establish the project baseline. Absence of estimates results in inaccuracies which result in time and cost under/overruns. The activity of estimating reduces error. 2. How does the culture of an organization influence the quality of estimates? Organization culture can influence project estimates depending on the importance the organization places on estimating. Use of top-down versus bottom-up estimating can influence estimates. How padding is handled strongly influences estimates. How organization politics is tolerated can severely influence estimates. 3. What are the differences between bottom-up and top-down estimating approaches? Under what conditions would you prefer one over the other? Top-down estimates are typically used in the project conceptual phase, and depend on surrogate measures such as weight, square feet, ratios. Top-down methods do not consider individual activity issues and problems. Top-down estimates are good for rough estimates and can help select and prioritize projects. Bottom-up time and cost estimates are usually tied directly to the WBS and a work package. These estimates are made by people familiar with the task, which helps to gain buy-in on the validity of the estimate. Use of several people should improve the accuracy of the estimate. Bottom-up estimates should be preferred if time to estimate is available, estimating cost is reasonable, and accuracy is important. 4. What are the major types of costs? Which costs are controllable by the project manager? Direct, direct overhead, and general and administrative costs. Direct costs are controllable by the project manager. Direct overhead and general and administrative costs are only controllable in the sense that if the resource or project is finished early or late the costs will continue for the duration of the project. 5. Why is it difficult to estimate mega project (i.e., costs and benefits (i.e. airports, stadiums, etc.) costs and benefits? First, the time horizon of 2-5 years to complete large, complex projects makes it difficult to accurately forecast costs and user needs. Second, the sheer complexity of these kinds of projects make it difficult to accurately estimate all of the costs. Third, the severity of the risks involved are significant. When things go wrong, they go wrong is a big way. While such conditions would suggest a very conservative estimate, the opposite occurs. Either blind enthusiasm or calculated deception is used to promote an exaggerated case for the project. 6. Define what a “white elephant” is in project management? Provide a real life example. A white elephant is a burdensome possession in which the owner cannot easily dispose of and whose cost (particularly upkeep) is out of proportion with its usefulness. Examples include dormant Olympic and World Cup stadiums, the Concorde, or little used vacation homes. Exercises 1. Calculate the direct cost of labor for a project team member using the following data: Hourly rate: $40/hr Hours needed: 80 Overhead rate: 40% Direct Cost of Labor: 80 x $40 = $3,200 Note: Overhead costs are not included in direct cost of labor. They are included in Total Direct costs. So if the question asked what the “Total” direct costs would be then the answer would be: $3,200 + ($3,200 x .40) = $4,480 2. Mrs. Tolstoy and her husband, Serge, are planning their dream house. The lot for the house sits high on a hill with a beautiful view of the Appalachian Mountains. The plans for the house show the size of the house to be 2,900 square feet. The average price for a lot and house similar to this one has been $120 per square foot. Fortunately, Serge is a retired plumber and feels he can save money by installing the plumbing himself. Mrs. Tolstoy feels she can take care of the interior decorating. The following average cost information is available from a local bank that makes loans to local contractors and disperses progress payments to contractors when specific tasks are verified as complete. 24% Excavation and framing complete 8% Roof and fireplace complete 3% Wiring roughed in 6% Plumbing roughed in 5% Siding on 17% Windows, insulation, walks, plaster, and garage complete 9% Furnace installed 4% Plumbing fixtures installed 10% Exterior paint, light fixtures installed, finish hardware installed 6% Carpet and trim installed 4% Interior decorating 4% Floors laid and finished a. What is the estimated cost for the Tolstoy’s house if they use contractors to complete all of the house? Estimated total cost for the house is $348,000 (2,900 sq. ft. x $120 per foot). b. Estimate what the cost of the house would be if the Tolstoys use their talents to do some of the work themselves. Estimated savings of Serge’s plumbing work and Mrs. Tolstoy’s interior decorating: Plumbing roughed in 6% x $348,000 = $20,880 Plumbing fixtures installed 4% x $348,000 = $13,920 Interior decorating 4% x $348,000 = $13,920 Total saving = $48,720 Estimated total cost for the completed house using their talents is $299,280 ($348,000 - $48,720). 3. Below is a project WBS with cost apportioned by percent. If the total project cost is estimated to be $600,000, what are the estimated costs for the following deliverables? a. Design? $240,000 b. Programming? $120,000 c. In-house testing? $240,000 What weaknesses are inherent in this estimating approach? a. Requires good, realistic historical data. b. If total cost estimate is off, all other costs will be off. c. Project must be very similar to past projects for sub-deliverables to be useful. 4. Firewall Project XT. Using the “complexity weighting” scheme and the function point complexity weighted table shown below, estimate the total function point count. Assume historical data suggest five function points equal on person month and six people can work on the project. Complexity Weight Table Number of inputs 10 Rated complexity low Number of outputs 20 Rated complexity average Number of inquiries 10 Rated complexity average Number of files 30 Rated complexity high Number of interfaces 50 Rated complexity high a. What is the estimated project duration? b. If 20 people are available for the project, what is the estimated project duration? c. If the project must be complete in six months, how many people will be needed for the project? The total function point count is: Complexity Weighting Element Count Low Average High Total Inputs 10 10 x 2 = 20 Outputs 20 20 x 6 = 120 Inquiries 10 10 x 4 = 40 Files 30 30 x 12 = 360 Interfaces 50 50 x 15 = 750 TOTAL = 1,290 a. 1290 / 5 function points = 258 person months. Assuming six people available, the project duration will be approximately 43 months (258 / 6 = 43). b. The project duration will be approximately 12.9 months if 20 people are available (258 / 20 = 12.9). 43 people will be needed to complete the project in approximately 6 months (258 / 43 = 6). Case 5.1 Sharp Printing, AG Three years ago the Sharp Printing (SP) strategic management group set a goal of having a color laser printer available for the consumer and small business market for less than $200. A few months later the senior management met off-site to discuss the new product. The results of this meeting were a set of general technical specifications along with major deliverables, a product launch date, and a cost estimate based on prior experience. (Rest of case not shown due to length.) 1. At this point what would you do if you were the project manager? This is a tough case for students to get a handle on because there is no obvious direction that leads to an acceptable strategy for the majority of the class. This case has served as a homework case, an in-class case, and as an exam case. Current state: The laser printer is a high-profile, strategic project to increase revenue. Time to market is important. It is reasonable to assume the bottom-up estimate is more accurate than the initial macro estimate. Immediate actions: Lauren needs to quickly inform top management of the discrepancy between the macro estimate and the WBS estimate. Lauren should be prepared with a plan of action for any preferred plan of action she has to offer. Student suggestions: The first choice for many students will be to change the project scope. Since little information is given, this is an easy solution that avoids hard questions. Almost all students relate to the project matrix found in Chapter 4. They will select time as critical and cost as flexible, but minimized. Some creative students will suggest a partnering arrangement with another organization that can provide expertise and reduce costs. This is a good discussion point and a viable approach. Cancel the project. This alternative is not received well because the laser printer is first priority. The hard facts are that senior management must deal with the time and cost discrepancies. If management is not willing to increase cost or reduce scope, canceling the project is viable. The case was developed from a real situation where the project was cancelled because of cost and advanced technology. 2. Was top management acting correctly in developing an estimate? Yes, top management at Sharp Printing (SP) was acting correctly in developing an estimate based on prior experience. When initiating a new project, it is common practice for senior management to rely on past experiences and historical data to develop initial cost estimates. This approach provides a starting point for budgeting and planning purposes. By basing the cost estimate on prior experience, senior management at SP can: • Utilize insights gained from similar projects in the past. • Make informed decisions regarding project feasibility and resource allocation. • Provide a preliminary budget for the project without having to conduct a detailed cost analysis at the outset. However, it's important to recognize that this initial estimate is likely to be refined and adjusted as the project progresses and more detailed information becomes available during the planning and execution phases. 3. What estimating techniques should be used for a mission critical project such as this? For a mission-critical project like developing a color laser printer for the consumer and small business market, several estimating techniques should be used to ensure accurate cost estimation and budgeting. These techniques include: 1. Analogous Estimating: • Use historical data from similar projects, such as the development of previous printers or similar electronic devices, to estimate costs. • Adjust the historical data to reflect any differences in scope, complexity, or technology. 2. Parametric Estimating: • Use mathematical models to estimate costs based on specific project parameters such as size, weight, features, and production volume. • For example, the cost per unit could be estimated based on the number of components, assembly time, and material costs. 3. Bottom-Up Estimating: • Break down the project into smaller, more manageable components and estimate the costs of each component individually. • Sum the costs of all components to arrive at a total project cost. • This technique is particularly useful for complex projects with many detailed components. 4. Vendor Bid Analysis: • Obtain cost estimates from vendors for materials, components, and services. • Compare and analyze bids from multiple vendors to ensure competitiveness and accuracy. 5. Expert Judgment: • Seek input from industry experts, engineers, and project managers with experience in developing similar products. • Use their expertise to validate cost estimates and identify potential risks and uncertainties. 6. Reserve Analysis: • Include contingency reserves in the cost estimate to account for potential risks and uncertainties. • Allocate reserves for known unknowns and unknown unknowns to mitigate the impact of unexpected events. 7. Monte Carlo Simulation: • Use simulation techniques to model different scenarios and estimate the range of possible project costs. • Incorporate variables such as material costs, labor rates, production volumes, and market demand to assess the project's cost uncertainty. By employing a combination of these estimating techniques, Sharp Printing (SP) can develop a more accurate and reliable cost estimate for the color laser printer project. This will help ensure that the project is completed within budget and meets the company's strategic objectives. Alternative to Case, Part B Top management refuses to alter the scope of the project. What action would you suggest? Why? Author's note: This case is designed to illustrate the types of problems that emerge when top-down and bottom-up estimates do not agree. This situation is far more prevalent in reality than we care to admit. Once project bottom-up time and cost estimates have been announced (usually by a senior manager), it is difficult to backtrack—given the strong egos of senior managers who do not wish to be pronounced “wrong.” Selling the accurate bottom-up WBS estimates must include some face-saving (wiggle room) for those responsible for the macro estimates. Case 5.2 Post Graduation Adventure Josh and Mike met each other as roommates during freshmen year at MacAlister College in St. Paul, Minnesota. Despite a rocky start they became best friends. They are planning on going on a two-week adventure together to celebrate their graduation in June. Josh has never been to Europe and wants to visit France or Spain. Mike spent a semester abroad in Aarhus, Denmark, and traveled extensively in northern Europe. Even though he never went to France or Spain, Mike wants to go to some place more exotic like South Africa or Vietnam. For the past week they have been arguing back and forth over where they should go. Josh argues that it will cost too much to fly to South Africa or Vietnam, while Mike counters that it will be much cheaper to travel in Vietnam or South Africa once they are there. Each of them agreed that they can spend no more than $3,500 each on the trip and could be gone for only two weeks. (Rest of case not shown due to length.) This is a student friendly case/exercise designed to have student’s use some basic estimating techniques to make a decision as to where to go on post-graduation celebration trip. Information provided below was obtained via internet searches made on April 17, 2013 and are subject to change. Hints: You need to set some constraints in advance; otherwise, variability will be significant. We tell our students that all flights are from Minneapolis, MN to the capital city of the specific country. The students will be back packing and living in hostels or budget accommodations. Prices will vary significantly in the future with different conclusions. This is ok since the objective of the case is the process used to make estimates and choices not the actual choices. 1. Assume you are either Mike or Josh, how would you go about making a decision using project management methodology? The case requires a top-down approach to estimating the cost of different proposed trips to assess the financial feasibility of different options. A good place to start would be to construct a high level WBS to obtain estimates of major costs associated with the trip. For example, major costs would likely include: Airfare to selected country In country travel Lodging Food Discretionary expenses More sophisticated breakdowns would also include: Miscellaneous cost (i.e., visa, vaccinations) Contingency fund Students are unlikely to include contingency funds since they have not been exposed to the importance of contingency funds which appears in Chapter 7 on Risk Management. Still, this would be a good opportunity to point out the importance of such consideration given the uncertainties involved both in the estimates and what can occur on their trip. 2. Looking first at only cost, what decision would you make? Utilizing the cost breakdown structure described above, the following estimates were obtained for the four choices: Country: Spain France Vietnam South Africa Airfare 1,800 1,500 2,800 2,100 In country Travel 80 100 40 80 Food/Lodging 1,060 1,080 78 250 Discretionary 200 250 175 200 Miscel 50 50 185 250 Contingency 350 350 350 350 Total $3,540 $3,330 $3,628 $3,230 Based on initial costs estimates travelling to Vietnam and Spain would be removed from consideration. Josh and Mike would be best served taking a more bottom up approach to refining the estimates for travelling to South Africa or France. 3. After cost, what other factors should be considered before making a decision? There are a variety of factors that need to be taken into consideration in deciding which country to visit. They include safety, weather, logistics (ease of getting around), sense of adventure, command of language, culture shock, etc. Naturally, another important consideration is whether the students have contacts in any of the countries. Visiting natives can reduce cost and enhance the richness of the trip. Appendix 5.1 Exercise Norwegian Satellite Development Company Cost estimates for World Satellite Telephone Exchange Project NSDC has a contract to produce eight satellites to support a worldwide telephone system (for Alaska Telecom, Inc.) that allows individuals to use a single, portable telephone in any location on earth to call in and out. NSDC will develop and produce the eight units. NSDC has estimated that the R&D costs will be NOK (Norwegian Krone) 12,000,000. Material costs are expected to be NOK 6,000,000. They have estimated the design and production of the first satellite will require 100,000 labor hours and an 80 percent improvement curve is expected. Skilled labor cost is NOK 300 per hour. Desired profit for all projects is 25 percent of total costs. A. How many labor hours should the eighth satellite require? 100,000 labor hours x .512 = 51,200 labor hours for the 8th unit B. How many labor hours for the whole project of eight satellites? 100,000 labor hours for 1st unit x 5.346 = 534,600 total for 8 units (534,600 hours x NOK 300 = NOK 160,380,000) C. What price would you ask for the project? Why? Labor (534,600 hrs x NOK 300) = NOK 160,380,000 R&D = NOK 12,000,000 Material = NOK 6,000,000 Total = = NOK 178,380,000 x 1.25 profit NOK 222,975,000 D. Midway through the project your design and production people realize that a 75 percent improvement curve is more appropriate. What impact does this have on the project? 80% improvement = 534,600 labor hours 75% improvement = 480,200 labor hours Difference = 54,400 labor hours x NOK 300 = NOK 16,320,000 E. Near the end of the project Deutsch Telefon AG has requested a cost estimate for four satellites identical to those you have already produced. What price will you quote them? Justify your price. 12 units = 100,000 lhrs for first unit x 6.315 (75%) = 631,500 lhrs First 8 units = 100,000 x 4.802 (75%) = 480,200 lhrs Difference = 151,300 lhrs Additional 4 units = 151,300 lhrs x NOK 300 = NOK 45,390,000 1/2 material of 6,000,000 = NOK 3,000,000 Total direct costs = NOK 48,390,000 1.25 profit = NOK 60,487,500 Some students prefer to figure costs and profits on 80% improvement and include a charge for R&D. Solution Manual for Project Management: The Managerial Process Erik Larson, Clifford F. Gray 9781259666094, 9780078096594
