Don't Add Risk And Double Investment Requirements By Estimating Project Budgets Incorrectly


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Many organizations need to set aside funding to conduct their own projects. How much funding, though? Poor project estimating leads to poor business forecasting and that can have a big impact on your organization's success. Learn the 4 methods typically used to estimate projects and the error (and risks) associated with each.

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Don't Add Risk And Double Investment Requirements By Estimating Project Budgets Incorrectly

  1. 1. Don’t Add Risk And Double Investment Requirements By Estimating Project Budgets Incorrectly Ed Kozak contractor that we’re subbing to uses thisAfter 13 years of budgeting and same formula and if it’s good enough for them it’s good enough for us.” Themanaging projects I went to work for anIT firm during the heyday of the Internet formula itself assigned what appeared toBubble. My new firm was hired as a be an arbitrary cost to each of therecommended third-party by the different types of statuses of people onecontractor to consolidate and reduce the might find in a pension database. Forerrors in pension databases before being example, one who still works for theloaded onto the contractor’s site for call company is an ACTIVE and each personcenter management. I was astounded to in this category was assigned a specificsee that there was no cost accounting cost per head, for the sake of argument,system in place with which I would be let’s say 40 cents. Employees who noable to track costs. “We’re the only one longer worked for the company werein our niche” said the company President labeled TERM for terminated and were“Trust me, we make more than enough further broken down into Vested Termsmoney.” (VT) and Non-Vested Terms (NVT). VTs were assigned a second cost perI was further astounded when it came head, say 35 cents, while those labeledtime to work on my first proposal for as NVT were assigned a third cost perthem. Instead of estimating how much head, say 20 cents. Two other categoriesthe work would cost by figuring out the that were sought out were Retirees, RET,required number of labor hours needed and those listed in the system who wereto perform the job and multiplying that now deceased, DEC. Employees labelednumber times labor rates and overhead RET were assigned a fourth costmultiples, I was given a parametric category, 30 cents per head, while thoseformula to use—something that based who fell into the category DEC fell intothe cost of the project not on our labor the fifth category and were assigned ahours but on some variables found in the cost of 15 cents per head. Prior todatabase that we were to cleanse. When submitting a proposal to a client weI questioned whether this was the needed to receive the most recentoptimal estimating technique to use the electronic copy of table of their pensionSenior VP replied to me “It’s obvious database that contained all of theyou don’t know our industry. The employees and their respective statuses
  2. 2. so that we could correctly count the test it, fix the errors, and then test thenumber of people that fell into each fixes. We had to incorporate businesscategory. The cost of the work that rules into our code as well. Many of ourwould be proposed to the customer clients were large corporations that hadwould then be calculated as grown by acquiring other firms and so one client could have 12 different# Active Employees x .40/ Active pension plans in place, each representingpersons a division of that company that was an#Vested Terms x .35/VT persons independent company in its own right#Non-Vested Terms x .20/NVT persons that had gotten acquired. To add to the#Retirees x .30/RET persons complexity, employees could possibly+ #Deceased x .15/DEC persons. work for more than one division during the course of his or her employment andAs mentioned earlier, this estimating so would have different rules applyingmethod was based on the model that the for benefit accruals. The bottom line isprime contractor used. However, it was that this was intense work requiringused by the prime to calculate the costs 24,000 person-hours worth of work overexpected per year to cover the volume of an 18-month period and the cost ofcalls to their call center and was based which couldn’t be extrapolated using aon the prime’s historical information. formula to calculate the anticipatedThat is, during a given year they workload for a call center. For this typeexpected to get a certain number of calls of work a different choice of estimatingfrom Active employees with questions method should have been used, butand concerns about their pensions, which one?slightly less from Vested Terms andslightly less from Retirees who werealready collecting a pension (Obviously, The Four Basic Estimating Methodsdeceased employees and Non-VestedTerms still had to have data processed Four basic estimating methods areeven though there wouldn’t be any calls available to project managers—from them, so they were charged a Apportioned Estimating, Parametricnominal rate). By keeping track of the Estimating, Bottom-Up Estimating, andnumber of calls, the type of employee Expert Opinion. Each has its strengthsmaking the call, and the amount of time and weaknesses and each introduces itsrequired to service each call across all of own inherent risk into a project. Theits clients, the contractor was able to use key to using any of them is to understandit to calculate an effective yearly service what type of work it’s best suited for andfee to charge its clients and to estimate to understand its limitations.costs for new ones. Expert Opinion is nothing more thanThe thing that the Management of my what it sounds like—an educated guesscompany didn’t realize was that our about how much a task or a project willwork was completely different. We cost made by a subject-matter expert.weren’t managing a call center. We On the positive side, it’s simple,were writing computer code to extract straightforward, and takes little time todata from numerous tables, compare it, produce. Little or no historical data isEstimating Project Budgets – Which Method Should You Use? 2©Successful Projects For Leaders. No portion of this document may be copied or distributed without the expressedwritten consent of the author.
  3. 3. required to make this estimate and it’s other. Take for example, a cementvery suitable, in fact, probably the most contractor that is in the business ofsuitable, for cutting edge projects that pouring driveways for its customers.have never been done before. On the Each driveway requires the grading ofnegative side, the estimate itself can be the land, the delivery of the sub base,off by a margin of 100%, by its very wooden framing material, placement ofnature it’s very subjective, being based the reinforcing material, the pouring ofon opinion, and can suffer from the concrete, the finishing, and thesomething known as estimating bias, that removal of the framing material. As theis, preference toward a particular result size of the desired driveway increases soinfluenced by the estimator. The best does the added material, the additionalway to minimize estimating bias, by the concrete, and the additional laborway, is to have a pool of experts required to pour and finish. Assumingindependently come up with their own the cost of the lumber to frame theestimates and, if there are large driveway out is minor compared to thediscrepancies, have the group resolve the time required to frame the driveway,differences. If discrepancies are small pour the concrete, finish the concrete,an average of the estimates can be taken. and the cost of the concrete itself, we can find a way of relating the cost for aParametric Estimating has already driveway to the number of cubic yardsbeen discussed in the example but a of concrete needed for the driveway.formal explanation is given here as well. What would be needed would be to keepA parametric estimate is one where the historical information showing thecost estimate is not based on labor amount of concrete used along with thedollars but on some other variable that total labor time required to frame, pour,itself is based on labor dollars. It is and finish. Let’s say that contractorassumed that the labor and that other recorded the data from his past 10 clientsvariable are linearly related to each as follows: Driveway Dimension Concrete Labor Time 2 3 Client Area (ft ) (yds ) Framing Finishing Total 1 750 15’ x 50’ 9.26 2.86 hrs 7.5 hrs 10.36 hrs 2 525 15’ x 35’ 6.48 2.2 hrs 5.25 hrs 7.45 hrs 3 315 9’ x 35’ 3.89 1.94 hrs 3.15 hrs 5.09 hrs 4 280 8’ x 35’ 3.46 1.89 hrs 2.8 hrs 4.7 hrs 5 450 9’ x 50’ 5.56 2.6 hrs 4.5 hrs 7.1 hrs 6 400 8’ x 50’ 4.94 2.55 hrs 4 hrs 6.55 hrs 7 900 18’ x 50’ 11.11 3 hrs 9 hrs 12 hrs 8 630 18’ x 35’ 7.78 2.33 hrs 6.3 hrs 8.63 hrs 9 810 18’ x 45’ 10 2.77 hrs 8.1 hrs 10.87 hrs 10 675 15’ x 45’ 8.33 2.64 hrs 6.75 hrs 9.39 hrsBy dividing the amount of concrete used square foot of driveway roughly requiresby the total hours in each case we can .015 clock hours of time. Assuming thesee in this simplified example that one contractor uses a four-person crew, afterEstimating Project Budgets – Which Method Should You Use? 3©Successful Projects For Leaders. No portion of this document may be copied or distributed without the expressedwritten consent of the author.
  4. 4. factoring in the labor rate, profit, and software package to perform a linearany other overhead rates let’s assume the regression that will fit the data to thecontractor bills $240/hour for this work. function of a line and identify whichAt .015 clock hours of time, one square variables are the strongest to use tofoot of driveway costs $3.60 of labor account for the cost. Another negative istime. After the contractor has gone the uncertainty in the parametricthrough this calculation one time he can estimate. While the uncertainty isn’t asuse the information to make future bad as that of expert opinion, it can haveestimates based solely on the number of a margin of error of 75% if not enoughsquare feet of driveway: historical information is used or if the estimate is applied incorrectly.Cost = Number of Sq. Ft of drivewaytimes $3.60/Sq. Ft. + Material Costs Apportioned Estimating, otherwise known as Top-Down Estimating,Material Costs: Concrete: #Sq. Ft. of Analogy Estimating, or the Analogydriveway times .012348 Cubic Yards Method, assumes that the work to beConcrete needed per Sq. Ft of driveway done is very similar to work that has@ $75 Cubic. Yard + Reinforcement @ been done in the past. What separates$.10/Sq. Ft. of driveway. apportioned estimating apart from parametric estimating is that quite oftenAs one can see, a major positive for this only one prior sample is used instead ofis that once the formula is created it many. The prior experience is comparedtakes no time whatsoever to use. It can to the new proposed project andeasily be changed to reflect new labor adjustments of price are made to factorrates, new overhead rates, and/or new in changes in scale, complexity, or otherconcrete costs. A drawback for this differences. In other words the startingmodel is the fact that it is not robust, that point for the analogy estimate is theis, if the model has been used to statement “We’ve done somethingcalculate the cost of driveways then one similar to this before only that that onecan’t assume without testing that it’s was (smaller/larger, more complex/lessapplicable to pavements, patios, garage complex, etc.” An adjustment factor isslabs, etc. Another drawback is that real then used to scale up or down the totaldata doesn’t fit cleanly into a formula as cost incurred for the prior is shown in this example. There is Once the top level (i.e. total) cost of thealways variability and the only way to work is known, the budgets for theensure that you’ve averaged out all of individual tasks can be assigned, orthat variability is to take plenty of data. apportioned, from the overall estimateTen prior examples certainly aren’t by comparing ratios from the priorenough. It might require twenty-five or experience. For example, if Task A ineven fifty. Can we be assured that all the prior job required 10% of the budgetrelationships are linear in nature? The then Task A for the new project also getsanswer is no. Have we factored in all of 10%, if Task B of the prior job requiredthe variables that we need to? The 25%, it is assumed that Task B for theanswer is that it depends on what we’re new project will require 25%, and so on.trying to model. The best way to The positives for apportioned estimatingproceed would be to use a statistical include its speed of use and the fact thatEstimating Project Budgets – Which Method Should You Use? 4©Successful Projects For Leaders. No portion of this document may be copied or distributed without the expressedwritten consent of the author.
  5. 5. it is based on the costs incurred of actual use it inappropriately to estimateprevious work. The biggest drawback projects as in the example providedfor this method centers on the use of gives it a higher margin of error than forhistorical data to make estimates for apportioned estimating which has afuture work. The older the data is the margin of error of 25%.more incorrect it can be. Labor ratesescalate, material prices fluctuate, Bottom-Up Estimating or the Costindustry practices change, Government Engineering Method is by far the mostregulations can be relaxed or be put into time consuming but most accurateeffect, reducing or adding costs, and estimating method of the four. Thetechnological advances can change the starting point for bottom-up estimating isnature of the way work is conducted. the WBS or Work Breakdown Structure. In short, the WBS is the roadmap for theA great analogy for the use of project. It lists out all of the tasks thatapportioned estimating is the budgeting need to be performed in order to getfor a wedding reception. No matter what from A to Z as well as their subtasks andone’s budget is, a wedding reception can their subtasks’ subtasks. The startingstill be planned. From a limited male’s point for this estimating method is theperspective, the major categories of the smallest level task. The followingreception can be broken down into: A. painstaking but necessary steps are usedLocation for the reception (includes food in order to properly create a bottom-upand beverages); B. Entertainment; C. estimate:Decorations, Including Centerpieces; D.Photographer. Roughly let’s assume that 1. Go to each WBS sub-task andA accounts for 75% of the cost of a write out an objective of, B accounts for 15%, C 2. From the schedule, determineaccounts for 4%, and D accounts for 6%. how much time has beenNo matter what one’s budget is, if you allocated to the task.tell me how much you have available to 3. For each sub-task, from thespend, I’ll tell you what you’re able to objective and schedule,get for that amount since I can apply determine how many people arethese percentages toward the total required and at what level—thisbudget you have to spend. Mind you, should be broken out on a week-you might end up using your cousin’s by-week basis.son to spin records to provide the 4. From the objective, determineentertainment, but it’s still a reception, what material or subcontractingnonetheless. Any project where the is required and get quotes onamount of work can be scaled up or each item.down to meet the available budget is a 5. Repeat this for each remaininggood candidate for apportioned taskestimating. 6. Apply the appropriate labor and overhead charges to the tasks.It’s worth noting that, although 7. Each sub-task rolls up to give theparametric estimating requires a larger overall estimate for a major task.sample of past project data, the tendency Each major task rolls up to giveto use too small of a sample size or to the estimate for the project.Estimating Project Budgets – Which Method Should You Use? 5©Successful Projects For Leaders. No portion of this document may be copied or distributed without the expressedwritten consent of the author.
  6. 6. gaps. Many bottom-up estimates willThe advantage of this method is the have subtasks that were estimated viaability to give as accurate an estimate as expert opinion or parametric methods. Ifpossible. When estimates are required to your projects historically are costingbe written down and signed by two much more than what had originallypeople (the estimator and a reviewer), been planned there could be one of manypeople can be held accountable for the reasons why this is so. If you’reestimates. Requiring the person who confident that your project manager iswill be responsible for managing the managing the project well and yourwork to estimate it as well increases the project team is performing the work tochances of it being as accurate as the best of their abilities the first thingpossible. Bottom-Up estimates can have that should be considered is to look ata margin of error of about 10% when the method used to create the estimates.created by skilled, experiencedestimators and individual work packageestimates are based on past experience. About the AuthorOne negative aspect of this method is thetime (and cost) commitment required to Ed Kozak, M.S., M.B.A., PMP is themake the estimate. Another is that it President and CEO of Successfulgives the estimator the ability to “pad” Projects For Leaders, internationalthe estimate, in other words, to falsely experts in project management processadd in additional money to the estimate improvement. The staff of Successfuldue to lack of confidence in the estimate. Projects For Leaders work withIt is important to remember that this companies along three main points ofestimate is only as good as the WBS it’s focus. First, they help companiesderived from. If shortcuts were taken improve their profitability by cuttingwhen the author(s) constructed the WBS wasteful project costs (upwards to 50%and tasks were left off then the estimate or more) and improve their overallwill not include budgets for those tasks. management of projects in order to reduce risk, schedule slippage, and unnecessary spending on productIn summary, four main types of rework. As a result their clients are able to exert more control over their projects;estimating techniques are available whenestimating projects budgets. The choice improve target schedule performance;of which one to use varies on the type of monitor and control cost performancework to be done, the availability of past better; increase their success at hittingproject data, the level of comfort of the budget estimates; improve quality andaccuracy of the estimate, and the amount satisfaction; and recognize theof time set aside to create the estimate. substantial financial benefits that comeIt is a novice mistake to think that only along with method could be and should be usedto create the budget for a project. In Second, Successful Projects For Leadersfact, estimators may use one method as is hired as project turnaround expertsfar as they can take it and then use one and is brought in on critical projects thator more different methods to fill in any are in the midst of schedule, budget, and/or quality issues or projects that areEstimating Project Budgets – Which Method Should You Use? 6©Successful Projects For Leaders. No portion of this document may be copied or distributed without the expressedwritten consent of the author.
  7. 7. having continual setbacks. They analyze offices, and project management and is athe problems, set a new budget and frequent conference speaker.schedule, and work with the incumbentproject management team to bring themto completion.A third benefit that Successful ProjectsFor Leaders offers is their availability tobe out-sourced by Organizations to serveas the Chief Projects Officer. In thisrole, Successful Projects For Leadersonly develops standards and practicesdirected at the effective execution ofprojects and the attainment of schedule,cost, scope, and quality objectives, butalso communicates enterprise-levelobjectives to the respective projectgroups in the most-appropriate way forthem to follow and communicatesproject information to Management.This overcomes the problem common tomany organizations that no connectionbetween Operations and project groupsexists and no structured, consistent, andmeaningful flow of information betweenthese two groups occurs, allowingManagement to determine if efforts areefficient and effective, if projects arestill the best ones to support strategicobjectives, whether there areperformance issues associated withmeeting objectives.Ed is an accomplished professional withhas over twenty-three years experienceas a consultant, manager, executive,facilitator, and instructor that includesproject/program manager experience inthe private and Government sectorsmanaging multi-year, multi-milliondollar programs for his clients in fieldssuch as IT, healthcare, research,development, and manufacturing. Hebrings his expertise to managementteams in strategic planning, process re-engineering, program managementEstimating Project Budgets – Which Method Should You Use? 7©Successful Projects For Leaders. No portion of this document may be copied or distributed without the expressedwritten consent of the author.