Chapter 7:

Project Cost Management

Information Technology Project

Management,
Fifth Edition
 Learning Objectives
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

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 Learning Objectives (continued)
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

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 The Importance of Project Cost
Management
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 43 percent in
2002; other studies found overruns to be 33-34
percent

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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 like dollars
Project cost management includes the processes
required to ensure that the project is completed within
an approved budget
Project managers must make sure their projects are well
defined, have accurate time and cost estimates and have
a realistic budget that they were involved in approving

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 Reasons for Cost Overruns
When projects start with unclear or overly optimistic
budgets, there’s a high chance of going over budget
later. cost estimates from the outset
Many of the original cost estimates for IT projects are low
to begin with and based on very unclear project
requirements which makes budgeting harder.
Many IT professionals think preparing cost estimates is a
job for accountants when in fact it is a very demanding
and important skill that project managers need to acquire
Many IT projects involve new technology or business
processes which involve untested products and inherent
risks

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 Project Cost Management Processes
There are three project cost management
processes:
Cost estimating: developing an approximation or
estimate of the costs of the resources needed to
complete a project
Cost budgeting: allocating the overall cost
estimate to individual work items to establish a
baseline for measuring performance
Cost control: controlling changes to the project
budget

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Project Cost Management Summary

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 Basic Principles of Cost Management
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
$2 profit per $100 revenue  2% profit margin
Life cycle costing considers the total cost of
ownership, or development plus support costs, for a
project
A project could take 2 years to build and be in place for
10 years; costs and benefits must be estimated for the
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 Cost of Software Defects

It is much more cost-effective to spend money on

defining user requirements and doing early testing on IT
projects than to wait for problems to appear after
implementation
If it would cost $1,000 to repair a software defect in
the requirements and analysis phase but it would
cost $30,000 to fix it in the post-product release
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Basic Principles of Cost Management
Cash Flow Analysis: This is a way to estimate the
yearly costs and benefits of a project to understand
its cash flow. If multiple projects need a lot of cash in
the same year, the company might not be able to
support them all, which can reduce profits.
Tangible Costs and Benefits: These are costs or
benefits that are easy to measure in dollars. For
example, if a task was budgeted at $150,000 but only
cost $100,000, the $50,000 saved can be used
elsewhere, providing a clear benefit.
Intangible Costs and Benefits: These are harder to
measure in money terms. They include things like
resources spent on background research or benefits
like increased brand reputation or employee
satisfaction. Although these benefits add value, they
don’t have a clear dollar amount attached to them.
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Basic Principles of Cost Management
Direct costs are costs that can be directly related to
producing the products and services of the project
Salaries, cost of hardware and software purchased
specifically for 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
Cost of electricity, paper towels
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
To continue funding a failed project because a great
deal of money has already been spent on it is not a
valid way to decide on which projects to fund
Sunk costs should be forgotten

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Basic Principles of Cost Management
Learning curve theory states that when many items
are produced (or tasks are performed) repetitively, the
unit cost of those items decreases in a regular pattern
as more units are produced (or more tasks performed)
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
Recruiting and training costs for expected personnel
turnover during a project
Management reserves allow for future situations that
are unpredictable (sometimes called unknown
unknowns)
Extended absence of a manager; supplier goes out of
business
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 Cost Estimating
After developing a good resource requirements
list, PMs and their teams must develop several
estimates of the costs for these resources
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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 Cost Estimating
 What is a ROM Estimate?
 A ROM estimate is an early guess of what a project might cost, often called
a "ballpark" estimate or "guesstimate.“
 When is it Used?
 It’s usually done very early, even years before the project starts, to help
decide if a project is worth considering.
 Accuracy
 ROM estimates are not very precise. The actual cost could be 50% less or
even double the ROM estimate. For example, if a ROM estimate is
$100,000, the actual cost might range from $50,000 to $200,000.
 IT Projects
 In IT projects, especially software development, costs often go over
budget, so these estimates may be doubled to account for potential
overruns.

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 Cost Estimating
A budgetary estimate is used to allocate money
into an organization’s budget.
Many organizations develop budgets at least two
years into the future.
Budgetary estimates are made one to two years prior
to project completion.
The accuracy of budgetary estimates is typically -
10% to +25%
A budgetary estimate that costs $100,000 would range
between $90,000 to $125,000.

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Information Technology Project Management, Fifth Edition, Copyright 2007
 Cost Estimating
 What is a Definitive Estimate?
 A definitive estimate gives a very accurate cost prediction for
a project. It’s the most precise type of estimate.
 When is it Used?
 It’s used when accurate numbers are needed, like for making
purchase decisions and planning the final project costs.
 Example If a project needs to buy 1,000 computers soon, a
definitive estimate helps compare supplier prices and set
aside the right amount of money.
Timing and Accuracy
 This estimate is usually made within a year of the project’s
completion, with an accuracy range of -5% to +10%.

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 Types of Cost Estimates

It is important to provide supporting details

(assumptions, project scope, WBS, etc) used in
computing estimates so that it will be easier to prepare
updates as needed or similar estimates on other
projects.
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 Cost Management Plan
A cost management plan is a document that
describes how the organization will manage cost
variance on the project
For example, how to respond to proposals from
suppliers that are higher or lower than estimates
A large percentage of total project costs are often
labor costs, so project managers must develop and
track estimates for labor
Many organizations estimate the number of people or
hours they need by department or skill over the life
cycle of a project

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Maximum Departmental Headcounts by Year
 The table below shows the maximum number of people Northwest
Airlines determined to assign to each year of the project by
department
 Note the small number of contractors; contractors generally have
higher labor costs than in-house employees

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Information Technology Project Management, Fifth Edition, Copyright 2007
Cost Estimation Tools and Techniques
 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
 How similar the current and previous project are determining the
accuracy of the estimate. Using a different language or hardware can
skew the estimate
 Bottom-up estimates or Activity Based Costing : involve
estimating individual work items or activities and summing
them to get a project total
 The smaller the work items, the better the estimate but these estimates
are usually time intensive and expensive to develop

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Information Technology Project Management, Fifth Edition, Copyright 2007
Cost Estimation Tools and Techniques
 Parametric modeling: uses project characteristics
(parameters) in a mathematical model to estimate project
costs
For example, a model might provide an estimate of $50 per line
of code for a s/w development project based on the programming
language, level of expertise of the programmers, size and
complexity of the data involved, etc
Some models may be simpler such as a $10,000 ballpark
estimate per workstation in a large office automation project
based on history of similar projects during the same time period

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 Typical Problems with IT Cost Estimates1
 Estimates are rushed: Sometimes, estimates need to be made quickly
even when the full system details aren't clear yet.
 Lack of experience: The people making the cost estimates may not have
enough experience, especially on large projects.
 Not enough data: There might not be enough accurate or reliable
information to make good estimates.
 Bias toward underestimation: People tend to underestimate how long
tasks will take or how much they will cost.
 Skill levels ignored: Senior team members make estimates based on their
own skills but forget that junior team members might take longer.
 Management pressure: Management wants accurate estimates but also
wants to keep costs low to win bids or get internal funding.
 First estimates are remembered: Management often remembers the first
estimate but forgets how changes to the project affect the final cost.
 Keep communication open: The Project Manager (PM) should always
keep communication clear to avoid confusion.

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 Sample Cost Estimate
See pp. 277-281 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

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 Surveyor Pro Project Cost Estimate

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 Surveyor Pro Software
Development Estimate

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 Cost Budgeting
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
An important goal is to produce a cost baseline
A time-phased budget that project managers use to
measure and monitor cost performance
Estimating costs for each major project activity over
time provides management with a foundation for
project cost control
Cost budgeting also provides info for project funding
requirements –at what point(s) in time will the money
be needed
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 Surveyor Pro Project Cost Baseline
 The Surveyor Pro project team could use the cost estimate (slide
27) along with the project schedule and other info to allocate costs
for each month as below

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

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 Cost Control
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
 Australia: problems with the installation of an ERP system at
Crane 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.
Only 65 are being monitored on a regular basis
 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.
Caused by massive mismanagement, embezzelment of funds and
unapproved changes in the project
 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. Cost of one of the bridges has grown from $1.1 billion to
$5.1 billion Maybe it takes the Terminator to help control costs!
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Information Technology Project Management, Fifth Edition, Copyright 2007
 Cost Control
Performance review meetings can be a powerful
tool to help control project costs
Knowing you must report on your progress is an
incentive for people to perform better
Performance measurement is another important tool
for cost control
There are many general accounting approaches for
measuring cost performance but earned value
management is a tool unique to project management

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 Earned Value Management (EVM)
 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
 Was a WBS item completed or approximately how much of
the work was completed
 Actual start and end dates
 Actual cost
 More and more organizations around the world are using
EVM to help control project costs

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 Earned Value Management Terms
 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
 $20,000 AC to accomplish task over two weeks - $15K AC
week 1and $5K week 2
 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
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Information Technology Project Management, Fifth Edition, Copyright 2007
 Rate of Performance
Rate of performance (RP) is the ratio of actual
work completed to the percentage of work planned
to have been completed at any given time during
the life of the project or activity
Brenda Taylor, Senior Project Manager in South
Africa, suggests this term and approach for
estimating earned value
For example, suppose the server installation was halfway
completed by the end of week 1; the rate of performance
would be 50% because by the end of week 1, the planned
schedule reflects that the task should be 100% complete
and only 50% of that work has been completed
The EV would thus be $5,000 after week 1 ($10,000*50%)

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 Earned Value Calculations
for One Activity After Week One

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 Earned Value Formulas

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 Earned Value Formulas
 Negative numbers for cost and schedule variance indicate
problems in those areas
 If CV is negative it means that performing the work cost more
than planned
 A negative SV means that it took longer than planned to
perform the work
 CPI can be used to estimate the projected cost of
completing the project based on performance to date (EAC)
 =1:the planned and actual costs are the same; <1: over
budget; >1: under budget
 SPI can be used to estimate the projected time to complete
the project
 =1: on schedule; <1 behind schedule; >1 ahead of schedule

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 Earned Value Chart for Project after Five Months
 EAC = $122,308 = BAC/CPI = $100,000/.81761
 ETC = 12.74 months = Original Time Estimate/SPI = 12 months/.94203

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 Earned Value Chart
The chart helps visualize how the project is
performing.
 If the project goes as planned, it will finish in 12
months at a cost of $100,000
 The actual cost line is always right on or above the
earned value line.
Interpretation: This means costs are equal to or more
than planned
 The planned value line is pretty close to the EV
line, just slightly higher in the last month
Interpretation: The project has been right on schedule
until last month when the project fell behind schedule
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 Earned Value Chart
 Many commercial organizations do not use EV
management
 Because IT projects do not have good planning information,
tracking performance against a plan might produce
misleading information
 Estimating percentage completion of tasks might also
produce misleading information.
 What does it mean to say a task is 75% complete after 3 months? 1
more month is needed to finish? Will finish after spending an
additional 25% of the planned budget? Could very well be no to both
of those question.
 To simply EV management,
 Use percentage completion of 0(not started), 50 (in progress)
and 100 (completed)
 Or, enter and collect EV data at summary levels of the WBS
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 Project Portfolio Management
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 management
1. Put all your projects in one database
2. Prioritize the projects in your database
3. Divide your projects into two or three budgets
based on type of investment
4. Automate the repository
5. Apply modern portfolio theory, including risk-return
tools that map project risk on a curve

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 Benefits of Portfolio Management
Schlumberger saved $3 million in one year by
organizing 120 information technology projects
into a portfolio
80% of the prjects overlapped
14 separate projects were trying to accomplish the
same thing
META Group research shows that:
Organizations that evaluate information technology
projects by what their business impacts are and
what their potential business values will be
implement projects that result in 25 percent more
improvement to the bottom line
Business executives state that using project
portfolio management allows managers to make
decisions faster and with more confidence
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 Best Practice
 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 interdependent projects
 The most successful organizations are taking a holistic view of focusing,
managing and measuring their IT efforts with an integrated combination of best
practice processes, training and technology

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Information Technology Project Management, Fifth Edition, Copyright 2007
 Best Practice
The most successful organizations are taking a
holistic view of focusing, managing and
measuring their IT efforts with an integrated
combination of best practice processes, training
and technology
Unfortunately, most organizations today are not
taking that approach

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 Using Software to Assist
in Cost Management
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
Several companies have developed methods to link
data between their project management software and
their main accounting systems

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