7 : Project Cost Management

IT4306– IT Project Management

Level II - Semester 4

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 Intended Learning Outcomes

• At the end of this lesson, you will be able to;

• Describe 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

• Identify the processes involved in cost budgeting

• Prepare a cost estimate and budget for an information

technology project

• Describe what the cost control is

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 7.1. The Importance of Project Cost Management

• IT projects have a poor track record for meeting budget

goals.
• The 2003 CHAOS studies showed the average cost overrun
(the additional percentage or dollar amount by which actual
costs exceed estimates) was 43 percent.
• U.S. lost $55 billion in IT projects in 2002 from cancelled
projects and overruns compared to $140 billion in 1994.*

*The Standish Group, “Latest Standish Group CHAOS Report Shows Project Success
Rates Have Improved by 50%,” A Standish Group Research Note (3/25/03).

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 What is Cost and Project Cost Management?

• 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, such as

dollars.

• Project cost management includes the processes required

to ensure that the project is completed within an approved
budget.

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 Project Cost Management Processes

• Estimating costs: Developing an approximation or estimate

of the costs of the resources needed to complete a project.

• Determining the Budget: Allocating the overall cost

estimate to individual work items to establish a baseline for
measuring performance.

• Controlling Costs: Controlling changes to the project

budget.

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 7.2. Basic Principles of Cost Management

• Most members of an executive board have a better

understanding and are more interested in financial terms
than IT terms, so IT project managers must speak their
language.

• Profits are revenues minus expenses.

• Life cycle costing 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.

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 Cost of Software Defects*

It is important to spend money up-front on IT projects to

avoid spending a lot more later.

*Collard, Ross, Software Testing and Quality Assurance, working paper (1997).

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 Basic Principles of Cost Management

• 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.

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 Basic Principles of Cost Management

• 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).

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 7.3. Planning Cost Management

A cost management plan

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

• A large percentage of total project costs are often labor

costs, so project managers must develop and track
estimates for labor.

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 Maximum Departmental Headcounts by Year

A large percentage of the costs of many IT projects are human

resource costs.

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 7.4. Estimating Costs

• Project managers must take cost estimates seriously if they

want to complete projects within budget constraints.

• It’s important to know the types of cost estimates, how to

prepare cost estimates, and typical problems associated
with IT cost estimates.

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Types of Cost Estimates

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 Cost Estimation Tools and Techniques

Basic tools and techniques for cost estimates:

• 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.

• Bottom-up estimates: Involve estimating individual work items or

activities and summing them to get a project total.

• Parametric modeling: Uses project characteristics (parameters) in

a mathematical model to estimate project costs.

• Computerized tools: Tools, such as spreadsheets and project

management software, that can make working with different cost
estimates and cost estimation tools easier.

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 Constructive Cost Model (COCOMO)

• Barry Boehm helped develop the COCOMO models for

estimating software development costs.
• Parameters include:
• Function points: Technology-independent assessments
of the functions involved in developing a system.
• Source Lines of Code (SLOC): A human-written line of
code that is not a blank line or comment.
• Boehm suggests that only parametric models do not suffer
from the limits of human decision-making.

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 Typical Problems with IT Cost Estimates

• Developing an estimate for a large software project is a

complex task that requires a significant amount of effort.

• People who develop estimates often do not have much

experience.

• Human beings are biased toward underestimation.

• Management might ask for an estimate, but really desire a

bid to win a major contract or get internal funding.

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 How to Develop a Cost Estimate and Basis of
Estimates

• See pages 299 - 304 for a detailed example.

• Before creating an estimate, know what it will be used for,
gather as much information about the project 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 change and
document the estimate.

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 Sample Cost Estimate
Surveyor Pro Project Cost Estimate

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Surveyor Pro Software Development Estimate

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 7.5. Determining the Budget

• Cost budgeting involves allocating the project cost estimate

to individual work items over time.

• The WBS is a required input for the cost budgeting process

because 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.

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Surveyor Pro Project Cost Baseline

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 7.6. Controlling Costs

• 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.

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 Media Snapshot

• Group Ltd. led to an estimated cost overrun of $11.5 million.*

• India: As many as 274 projects currently under implementation in
the Central sector are suffering serious cost and time overruns.**
• Pakistan: Pakistan has sustained a cost overrun of Rs 1.798 billion
(over
• $30 million U.S. dollars) in the execution of the 66.5 megawatt
Jagran Hydropower Project in the Neelum Valley.***
• United States: Northern California lawmakers were outraged over
Governor Arnold Schwarzenegger's announcement that
commuters should have to pay construction costs on Bay Area
bridges. Maybe it takes the Terminator to help control costs!****

*Songini, Marc L., “Australian Firm Wrestles With ERP Delays,” ComputerWorld (July 12,
2004).
**Srinivasan, G., “274 Central sector projects suffer cost, time overruns,” The Hindu Business
Line (May 4, 2004).
***Mustafa, Khalid, “Rs 1.8 billion cost overrun in Jagran hydropower project,” Daily Times
(November 19, 2002).
****Gannett Company, “Governor Refuses to Pay for Bay Bridge Cost Overruns,” News10
(August 17, 2004).
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 Summary

• Project cost management is traditionally a weak area in IT

projects, and project managers must work to improve
their ability to deliver projects within approved budgets.

• Main processes include:

• Estimating cost
• Determining the budget
• Controlling Costs

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