project cost management. learning objectives 2 understand the importance of project cost management...

Project Cost Management

Learning Objectives

2

Understand the importance of project cost management

Explain basic project cost management principles, concepts, and terms

Discuss different types of cost estimates and methods for preparing them

Understand the processes involved in cost budgeting and preparing a cost estimate and budget for an information technology project

Understand the benefits of earned value management and project portfolio management to assist in cost control

Describe how project management software can assist in project cost management

The Importance of Project Cost Management

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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 56 percent in 2004; other studies found overruns to be 33-34 percent

What Went Wrong?

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The U.S. government, especially the Internal Revenue Service (IRS), continues to provide examples of how not to manage costs A series of project failures by the IRS in the 1990s cost

taxpayers more than $50 billion a year A 2008 Government Accountability Office (GAO) report stated

that more than 400 U.S. government agency IT projects, worth an estimated $25 billion, suffer from poor planning and under performance

The United Kingdom’s National Health Service IT modernization program was called the greatest IT disaster in history with an estimated $26 billion overrun

What is Cost and Project Cost Management?

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Cost is a resource sacrificed or foregone to achieve a specific objective or something given up in exchange

Costs are usually measured in monetary units like dollars

Many IT project managers show little concern on cost overruns because of following reasons Many IT project cost estimates are low to begin with or The cost estimates are based on very unclear requirements PMs think its not their job to estimate cost IT projects involve new technology or business process

Project cost management includes the processes required to ensure that the project is completed within an approved budget

Project Cost Management Processes

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Estimating costs Developing an approximation or estimate of the costs of the

resources needed to complete a project Outputs of this process are activity cost estimates and

supporting detail, requested changes and updates to the cost management plan.

Determining the budget Allocating the overall cost estimate to individual work items

over time to establish a baseline for measuring performance Outputs of this process are a cost baseline, project funding

requirements, requested changes and updates to the cost management plan.

Controlling costs Controlling costs include monitoring cost performance, ensuring

that only appropriate project changes are included in cost revisions and informing stakeholders about authorized changes effecting project costs.

Outputs to this process are performance measurements, forecasted completion information and updates to cost management plan, cost estimates and organization’s process assets (as lessons learned)

Project Cost Management Summary

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Basic Principles of Cost Management

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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 Profits are revenues minus expenditures Profit margin is the ratio of revenues to profits Life cycle costing gives you an overview of cost incurred

by a project during its lifecycle. It 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. If an organization selects too many projects with high cash flow needs in the same year, the company won’t be able to support all its projects and maintain its profitabiliy

Cost of Downtime for IT Applications

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Downtime effects direct or indirect loss of revenue

What Went Right?

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Many organizations use IT to reduce operational costs

Technology has decreased the costs associated with processing an ATM transaction: In 1968, the average cost was $5 In 1978, the cost went down to $1.50 In 1988, the cost was just a nickel In 1998, it only cost a penny In 2008, the cost was just half a penny!


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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. In other words sunk costs should be forgotten.


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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 are 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)

Estimating Costs

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Project managers must take cost estimates seriously if they want to complete projects within budget constraints

After developing the activity resource requirements list PMs and project team must develop estimates for cost of these resources.

It’s important to know the types of cost estimates, how to prepare cost estimates, and typical problems associated with IT cost estimates

Types of Cost Estimates

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When conducting ROM estimates for IT projects the accuracy range is often much wider.

Budgetary estimate involves allocating money into an organization’s budget for the desired project.

Definitive estimate should be the most accurate of the three types of estimates.

All these estimates must provide supporting details (ground rules, assumptions, project descriptions and estimation tool & techniques)in order to facilitate preparation of updated estimate or similar estimate for another project.

Cost Management Plan

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A cost management plan is a document that describes how the organization will manage cost variances on the project

The cost management plan should covey information like how to respond to proposals that stand higher or lower than the estimated costs.

A large percentage of total project costs are often labor costs, so project managers must develop and track estimates for labor

Maximum Departmental Headcounts by Year for Northwest Airlines Project

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Cost Estimation Tools and Techniques

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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. Requires a good deal of expert judgment and is less costly than

others If the project to be estimated for example requires use of new

programming language or technology, this technique could result is too low estimate

Bottom-up estimates: Involve estimating individual work items or activities and summing

them to get a project total Using smaller work items increases accuracy of this cost estimate. Drawback – Very time consuming and therefore expensive.

Parametric modeling Uses project characteristics (parameters) in a mathematical model

to estimate project costs Parametric models are most reliable when the historical information

that was used to create the models is accurate, the parameters are readily quantifiable and the model is flexible in terms of size of the project.

Typical Problems with IT Cost Estimates

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Estimates are done too quickly Lack of estimating experience Human beings are biased toward

underestimation Management desires accuracy

Sample Cost Estimate

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See pages 265-270 for a detailed example of creating a cost estimate for the Surveyor Pro project described in the opening case

Before creating an estimate, know what it will be used for, gather as much information as possible, and clarify the ground rules and assumptions for the estimate

If possible, estimate costs by major WBS categories

Create a cost model to make it easy to make changes to and document the estimate

Surveyor Pro Project Cost Estimate

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Estimating Program Volume (COCOMOII)

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One measure of program volume is the number of Source Lines of Code, or SLOC

A SLOC is a human written line of code that is not a blank line or comment

Do not count the same line more than one time even if the code is included multiple times in an application

We typically work with a related number, thousands of SLOC, or KSLOC, when estimating

The Constructive Cost Model, or COCOMO popularized SLOC as an estimating metric


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If you are aware of the number of KSLOC your developers must write, and you know the effort required per KSLOC

You could multiply these two numbers together to arrive at the person months of effort required for your project

This concept is the heart of the estimating models


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*The above table shows some common values that researchers have found for this linear productivity factor


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OK, let’s apply this approach. Suppose we were going to build an e-commerce system consisting of 15,000 lines of code. How many person months of effort would this take using just this equation?

Productivity * KSLOC = 3.08 * 15 = Effort = 46 Person-Months

If all of your projects are small, then you can use this basic equation

Researchers have found, however, that productivity does vary with project size. In fact, large projects are significantly less productive than small projects

The probable causes are a combination of increased coordination and communication time, plus more rework required due to misunderstandings.


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This productivity decrease with increasing project size is factored in by raising the number of KSLOC to a number greater than 1.0

This exponential factor then penalizes large projects for decreased efficiency. The following table shows some typical size penalty factors for various project types


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So, after we do a size penalty adjustment, how many person months of effort would our 15,000 lines of code e-commerce system require? The answer is computed as follows:

Productivity * KSLOCPenalty = 3.08 * 15 1.030

= 3.08 * 16.27 = Effort = 50 Person-Months

OK, all of this is pretty straightforward. The next logical question is, “How do I know my project will end up as 15,000 SLOC?”

Estimating Function Points (COCOMOII)

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SLOC estimating is to start with function points, then use a process called backfiring to convert from function points to SLOC

Function Points were first utilized by IBM as a measure of program volume

Function points are a unit measure for software much like an hour is to measuring time, miles are to measuring distance or Celsius is to measuring temperature

The idea is simple. The program’s delivered functionality (and hence, cost) is measured by the number of ways it must interact with the users.


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To determine the number of Function Points, start by estimating the number of External inputs - are largely your data entry screens. If a

screen contains a tabbed notebook or similar metaphor then each tab would count as a separate external input

External interface files - are file based inputs or outputs. Each record format within the file, or in the case of XML, each data object type, would count as a separate interface file even if residing in the same physical file

External outputs - are your reports External queries - are message or external function

based communication into or out of your application Logical internal tables - are the number of tables in the

database assuming the database was 3rd normal form or better


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To convert from these raw values into an actual count of function points, you multiply the raw numbers by a conversion factor from the following table


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So, if we had a system consisting of 25 data entry screens, 5 interface files, 15 reports, 10 external queries, and 20 logical internal tables, how many function points would we have?

(25*4) + (5*7) + (15*5) + (10*4) + (20*10) = 450 FPs

Calculating SLOC (COCOMOII)

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The only remaining step is to use backfiring to convert from function points to an equivalent number of SLOC. This can be done using a table of language equivalencies. Some common values are as follows

Calculating SLOC & Effort (COCOMOII)

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So, to implement the above project (450 function points) using Java 2 would require approximately the following number of SLOC

450 * 46 = 20,700 SLOC And would require the following effort to

implement, assuming that this was an e-commerce system:

Productivity * KSLOCPenalty = 3.08 * 20.7 1.030

= 3.08 * 22.67 = Effort = 70 Person-Months

Surveyor Pro Software Development Estimate

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Determining the Budget

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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 Cost budgeting provides information for project

funding requirements. Specially for those projects which do not have all funds available when the project starts

Surveyor Pro Project Cost Baseline

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*Numbers are rounded, so some totals appear to be off.

Controlling Costs

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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 According to a report Pakistan has sustained Rs

1.798 billion cost overrun on 66.5 megawatt hydropower project in the Neelum Valley due to massive mismanagement, embezzlement of funds and changes made in the project without the approval of a competent authority.

Earned Value Management (EVM)

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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

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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

Example of EVA

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A $10,000 software project is scheduled for 4 weeks. At the end of the third week, the project is 50% complete and the actual costs to date is $9,000

Planned Value (PV) = $7,500 ($2500 PerWeek)Actual Cost (AC) = $9,000

Earned Value is (PV) * RP = $10000 * 0.5Earned Value (EV) = $5,000

What is the project health? Schedule Variance

= EV – PV = $5,000 – $7,500 = - $2,500 Schedule Performance Index (SPI) = EV/PV = $5,000 / $7,500 = .66 Cost Variance= EV – AC = $5,000 - $9,000 = - $4,000 Cost Performance Index (CPI) = EV/AC = $5,000 / $9,000 = .55

Objective metrics indicate the project is behind schedule and over budget.

On-target projects have an SPI and CPI of 1 or greater

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Forecasting Costs The CPI can be used to calculate the estimate at

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

If the project continues at the current performance, what is the true cost of the project?

Estimate At Complete = Budget At Complete (BAC) / CPI = $10,000 / .55 = $18,181

At the end of the project, the total project costs will be $18,181

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Earned Value Chart

This chart shows EVA values for a 12 months project worth $100,000

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Project Portfolio Management

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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 management1. Put all your projects in one database2. Prioritize the projects in your database3. Divide your projects into two or three budgets

based on type of investment4. Automate the repository5. Apply modern portfolio theory, including risk-

return tools that map project risk on a curve

Benefits of Portfolio Management

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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

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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

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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

Chapter Summary

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Project cost management is a traditionally weak area of IT projects, and project managers must work to improve their ability to deliver projects within approved budgets

Main processes include: Estimate costs Determine the budget Control costs

Assignment#1 Part2For the project proposed in the Part1 of this

assignment Develop the initial version of project scope

statement Develop the WBS for the project. Break down the

work to at-least level 2 Develop a Gantt chart for the project with

milestones and also mark the task dependencies. The assignment is due on 12 Nov 2013

Note: Please use the format for each of these elements as proposed in the course text book under Chapter3 and Chapter5.

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Quiz # 2

Develop a AOA network diagram for following data. Calculate the critical path? What is the shortest time to complete the project?

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Activity

Initial Node

Final Node

Task Duration

A 1 2 2

B 2 3 2

C 2 4 3

D 2 5 4

E 3 6 2

F 4 6 3

G 5 7 6

H 6 8 2

I 6 7 5

J 7 8 1

K 8 9 2