Cost Estimation in Project Management

Cost estimation
A cost estimate is the approximation of the cost of a program, project, or operation.
The cost estimate is the product of the cost estimating process. The cost estimate
has a single total value and may have identifiable component values.

Introduction
Cost estimation has great importance in project management as it provides
important information for decision making, cost scheduling and resource
management. Analogy cost estimation techniques, such as Constructive Cost
Modeling (COCOMO), involves employing cost profile data from historical
projects that are similar in design or operation, and calibrating the cost of current
system based on the software metric differences such as size and capacity. This
approach heavily depends on the availability of information from previous projects
and thus lack of reliable data often results in the inaccuracy of cost estimating.
Parametric cost estimation is an alternative to analogy cost estimation which
involves converting base information into parametric input and is capable of
producing more accurate cost estimates.

Uncertainty factors in cost estimation

The challenge with estimating cost is that it always involves some uncertainty.
Some of the factors that contribute to this uncertainty include.

 Experience with Similar Projects: The less experience you have with
similar projects, the greater the uncertainty. If you've managed similar
projects, you will be able to better estimate the costs of the project.
 Planning Horizon: The longer the planning horizon, the greater the
uncertainty. The planning horizon you are considering may be the whole
project or just a certain phase. Either way, you will be able to better
estimate costs for the time periods that are closer to the present.
  Project Duration: The longer the project, the greater the uncertainty.
This is similar to planning horizon in the sense that if a project is of a
shorter duration you are more likely to account for most of the costs.
 People: The quantity of people and their skill will be a huge factor in
estimating their costs. Early in the project, you may not even know the
specific people that will be on the project. That will increase the
uncertainty of your cost estimates.

Tools and techniques

EXPERT JUDGMENT
Expert judgment uses the experience and knowledge of experts to estimate the
cost of the project. This technique can take into account unique factors specific
to the project. However, it can also be biased.

ANALOGOUS ESTIMATING
Analogous estimating uses historical data from similar projects as a basis for
the cost estimate. The estimate can be adjusted for known differences between
the projects. This type of estimate is usually used in the early phases of a
project and is less accurate than other methods.

PARAMETRIC ESTIMATING
Parametric estimating uses statistical modeling to develop a cost estimate. It
uses historical data of key cost drivers to calculate an estimate for different
parameters such as cost and duration. For example, square footage is used in
some construction projects

BOTTOM UP ESTIMATING
Bottom-up estimating uses the estimates of individual work packages which are
then summarized or "rolled up" to determine an overall cost estimate for the
project. This type of estimate is generally more accurate than other methods
since it is looking at costs from a more granular perspective.
COST OF QUALITY

Cost of Quality (COQ) includes money spent during the project to avoid
failures and money spent during and after the project due to failures. During
cost estimation, assumptions about the COQ can be included in the project cost
estimate.

PROJECT MANAGEMENT ESTIMATING SOFTWARE

Project management estimating software includes cost estimating software

applications, spreadsheets, simulation applications, and statistical software
tools. This type of software is especially useful for looking at cost estimation
alternatives

COST ESTIMATING METHODS

Cost estimating is a valuable tool that is used in each of the acquisition phases.
There are a number of cost estimating techniques that can be used in estimating the
costs of a future and current weapon system. The use on a specific approach will
depend on how much information is available and where weapon system is in its
development and lifecycle. Most programs will use multiple techniques to get a
god cross reference of the accuracy of their estimates. A few of the most common
cost estimating techniques are listed in the Defense Acquisition Guidebook (DAG)
and are:

Parametric: The parametric technique uses regression or other statistical methods

to develop Cost Estimating Relationships (CERs). A CER is an equation used to
estimate a given cost element using an established relationship with one or more
independent variables. The relationship may be mathematically simple or it may
involve a complex equation (often derived from regression analysis of historical
systems or subsystems). CERs should be current, applicable to the system or
subsystem in question, and appropriate for the range of data being considered. [1]

Analogy: An analogy is a technique used to estimate a cost based on historical data

for an analogous system or subsystem. In this technique, a currently fielded
system, similar in design and operation to the proposed system, is used as a basis
for the analogy. The cost of the proposed system is then estimated by adjusting the
historical cost of the current system to account for differences (between the
proposed and current systems). Such adjustments can be made through the use of
factors (sometimes called scaling parameters) that represent differences in size,
performance, technology, and/or complexity. Adjustment factors based on
quantitative data are usually preferable to adjustment factors based on judgments
from subject-matter experts.

Engineering Estimate: With this technique, the system being costed is broken
down into lower-level components (such as parts or assemblies), each of which is
costed separately for direct labor, direct material, and other costs. Engineering
estimates for direct labor hours may be based on analyses of engineering drawings
and contractor or industry-wide standards. Engineering estimates for direct
material may be based on discrete raw material and purchase part requirements.
The remaining elements of cost (such as quality control or various overhead
charges) may be factored from the direct labor and material costs. The various
discrete cost estimates are aggregated by simple algebraic equations (hence the
common name “bottoms-up” estimate). The use of engineering estimates requires
extensive knowledge of a system’s (and its components’) characteristics, and lots
of detailed data.

Actual Costs: With this technique, actual cost experience or trends (from
prototypes, engineering development models, and/or early production items) are
used to project estimates of future costs for the same system. These projections
may be made at various levels of detail, depending on the availability of data. Cost
estimates that support a full-rate production milestone decision should be based on
actual cost data to the greatest extent possible. A common mistake is to use
contract prices as a substitute for actual cost experience. Contract prices should not
be used to project future costs (even when firm-fixed price) unless it is known that
the contract prices are associated with profitable ventures, and that it is reasonable
to assume that similar price experience will be obtained for subsequent contracts.