DTU ProjectLab - User contributions [en-gb]

Project Cost Estimation Methods

2022-03-22T21:20:05Z

S184301: /* About Cost Estimation */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management, since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is usually estimated at the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the timetable of the project <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply put, the budget of a project is essential for its success. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available such as analogous estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article, different kinds of cost estimating techniques will be examined, to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article mainly provides a discussion of when to use a selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further research through the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kinds of cost estimates are usually stated in monetary terms, to enable comparisons across projects. They can however also be stated in alternative units, such as staff hours or staff days, if the monetary values are not appropriate or relevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is often times one of the most essential things in order to gain approval from upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates typically increase in accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier. In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility to asses early on whether to proceed with the project or not. According to PMBOK, the accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used in this situation<ref name="three"/>.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. In this kind of situation, it can assist in finding a preliminary cost and budget strategy that is more accurate than that of the ROM, as it has a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise type of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is referred to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost Estimation at Different Stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are typically "carried out periodically during the duration of the project" according to PMBOK <ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity, rather than a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is that the controlling indicators of the project indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of project managers cost estimations techniques is influenced by a number of factors. This includes the size and scope of the project, the availability of data from previous projects, and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for completing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The type and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when completing estimates without having a lot of available information. Comparable estimates are used when a project has access to previous data on similar types of work, but lacks the specifics and resources for more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however be achieved more easily by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

Parametric estimating is a statistical approach for determining the cost, budget or duration required to complete a project, an activity, or a portion of a project. It uses a relationship between variables (a unit cost/duration and the number of units) to provide an accurate estimate. The size of the present project is then scaled in accordance with the observed association. For instance, in the construction of a highway, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
Like analogous estimating, parametric estimating requires historical data, but it differs from analogous estimating in its algorithmic approach and its use of additional quantitative parameters. At the same time, it accounts for the difference between new and old data. Depending on the level of underlying data built into the model, a high accuracy can be achieved.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the type of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data. Estimates are often times performed by a top-down estimation approach.

* Dividing the project into smaller tasks through the use of a WBS, and asking the people in charge of different tasks of the project to create estimates for how much time and how many resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|350px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation technique provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In the case of analogous estimation, it is applicable at the very basic level of the project, and it does not provide the most precise estimates. It is more appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in the preparation of the model and gathering historical data from past projects to apply to current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate is based on the sum of the activities of the project. It ignores the additional effort required for integrating the activities, while executing the enterprise and complex projects. Furthermore, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages, as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire experts as consultants. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

Different techniques for cost estimation, as well as when to apply them, have been reviewed in this article. ROM estimates are typically the only kind of estimation available at the start phase of a project, resulting in the analogous estimation and expert judgment most commonly being applied here. As a project progresses, the degree of information and data tend to rise and become more accurate, and the ROM can be replaced by budget estimates, followed by definite estimates. As Bottom-up, parametric and three-point estimation methods generally produce the most precise cost estimates, they are frequently required for definitive estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling. However it is worth noting that all methods have their limitations, and producing an exact cost estimate can be very difficult and sometimes close to impossible.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/estimating-project-cost/#2-rough-order-of-magnitude-vs-definitive-estimate</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Scrum 2

2022-03-22T21:14:55Z

S184301: /* References */

== Introduction ==

Scrum was introduced in 1986 by Hirotaka Takeuchi and Ikujiro Nonaka with an article named: ‘The New New Product Development Game’, published by Harvard Business Review<ref name="orginal scrum"/>. In the early 1990s it was further developed by Ken Schwaber and his company. Even though Scrum is spelled in all capital letters a lot of places, it is not an acronym. The word itself originated from rugby, where the term means a formation of players or a team.
Scrum was made to help provide organizations flexible solutions to problems. Scrum is an iterative process, with the time frame most commonly being between 2 weeks and a month. This time frame is called a sprint in Scrum terminology. However, this varies a lot depending on the organization needs.
Scrum has in recent years become a very popular project management framework. It is commonly used in companies who wish to become agile or lean. Together with the Kanban board, the Scrum framework has become an essential tool within agile and lean management.

Within the framework the Scrum Master manages a group through the following steps:

1. A Product Owner orders the work for a complex problem into a Product Backlog.

2. The Scrum Team turns a selection of the work into an Increment of value during a Sprint.

3. The Scrum Team and its stakeholders inspect the results and adjust for the next Sprint.

4. Repeat. <ref name="scrum guide"/>

This article will go through the steps of the Scrum framework and the ideas behind them.

== Values ==
[[File:Scrum values.jpg|400px|right|Fig 1: Scrum.org: Author]]
The Scrum framework is based upon 5 core values that are meant to help illustrate some of benefits of the framework. The five values are:

- Courage

- Focus

- Commitment

- Respect

- Openness

For a Scrum process to be successful, the scrum team must keep these values in mind. The teams must be courageous so that they can use this framework to solve tough and complex issues. Focus and Commitment are also essential. When working with complex issues it is important that the team participating in the process are focused and committed. Finally, this framework is used by teams of people and therefore the participants are forced to work together. To help ensure conflicts are avoided, participants are encouraged to be respectful and open towards their fellow teammates.

== Team ==
As mentioned before, the Scrum is performed by a small team of people. A Scrum team consists of a Product owner, a Scrum master and developers. The Scrum team is supposed to be self-managed and consisting of people with the necessary competences to achieve the goal. In order words, the teams should not be relying on any other manager or employees. The Scrum team can vary in size, however, smaller teams are preferable since it helps the team stay nimble and agile. According to the Scrum Guide<ref name="scrum guide"/>, a Scrum team should rarely exceed 10 people, but it does of course depend on the objective or goal of the organization.

===Developers===
One part of the Scrum team is Developers. Ken Scwaber and Jeff Sutherland describes developers as follows in their Scrum Guide: “Developers are the people in the Scrum Team that are committed to creating any aspect of a usable Increment each Sprint.”<ref name="scrum guide"/>. In addition to that, they are responsible for making the product at the end of each sprint. You do not need any specific skill in order to become a Developer, since the skill requirement relies heavily on the objective. The competences and background of the Developers varies a lot, however, there are a few characteristics most great Developers should possess, for example, the ability to work together in teams. However, according to the Scrum guide developers are always responsible for:

• Creating a plan for the Sprint, the Sprint Backlog

• Instilling quality by adhering to a Definition of Done

• Adapting their plan each day toward the Sprint Goal; and,

• Holding each other accountable as professionals. <ref name="scrum guide"/>

===Product Owners===
The product owner is often the key stakeholder of the project<ref name="workfront"/>. Their main purpose is ensuring the maximization of the value that the project intends to provide to the end customer. They do this by managing the product backlog which is an ordered list of the desired features the end product should have.

Product owners often takes the perspective of the customer or consumer of the product. This customer centric perspective is meant to help ensure that the product actually delivers on the goals set in the beginning of the process. The product owner is the role within the Scrum framework that acts the most like what a project manager does in a traditional project group. It is fine for a product owner delegate work within the Scrum team, but the product owner is accountable of not only the daily executions of Scrum events but also the final product. A product owner is often a person with knowledge of both the business and technical side of the project and can therefore act as a mediator between developers with different backgrounds. It is also recommended that the product owner is someone with great leadership since the person is in charge of the entire Scrum team and the process. The Scrum guide also emphasizes the importance of their only being one single person as product owner within every Scrum team: “The Product Owner is one person, not a committee. The Product Owner may represent the needs of many stakeholders in the Product Backlog. Those wanting to change the Product Backlog can do so by trying to convince the Product Owner.”<ref name="scrum guide"/>. This also means that, in order for a product owner to be successful, the other members of the Scrum team must trust and respect the product owner decisions.

The product owners key responsibilities can be summed up as follows:

- Defining the vision

- Prioritizing the product backlog

- Taking an overview of development stages

- Handling communications

- Knowing what the client needs

- Evaluating progress <ref name="workfront"/>

===Scrum Master===

In short, the Scrum master is responsible for the Scrum team’s effectiveness. A Scrum master is someone with a deep understanding and knowledge of the Scrum framework. This includes Scrum team roles, Scrum events and Scrum artifacts. One of the main responsibilities of the Scrum master is to make sure every participant understands the Scrum process and their individual roles and responsibilities. In addition to that, the Scrum master also helps outside of their respective scrum team. They can also help the organization around the Scrum team to have a better understanding of how the framework works. The Scrum master thereby serves the Scrum team, the product owner and the organization in numerous ways. They help team members with self-management and ensuring all of the events are done within the set timeframe. They help product owners with planning and backlog management, and finally they help the entire organization by educating and training employees in the Scrum framework.
In order to become an official Scrum master, you have to take a Scrum master certification course. There are many providers of these courses, and they vary in length.

== Scrum events ==

The entire Scrum framework is built around Scrum events. These events are: The sprint, sprint planning, daily Scrum, sprint review and finally sprint retrospective.
[[File:Scrum Sprint.jpg|600px|right|Fig 2: Wrike.com: Author]]
===The Sprint===

The sprint is the most essential scrum event. It is through this process that the goal of the entire Scrum framework is achieved. As with other events within the framework, the duration varies. The duration of the sprint depends on the organization and the goal of the framework. However, it is recommended that the sprints duration is at least under a month. It is also recommended that sprints remain the duration, or at least as close as possible, to help create stability and consistency.
The sprint consists of multiple events, such as Sprint Planning, Daily Scrum, Sprint Review and finally Sprint Retrospective.

===Sprint Planning===

Sprint planning is the very first step of the sprint and kicks off the process. Before starting the sprint a clear goal needs to be set. In this event, the Scrum team has a discussion, facilitated by the product owner, about which items from the product backlog should be included in this sprints sprint backlog. When choosing the sprint goals, it is important to consider that they must be achievable within one sprint and how to actually reach them. To help with this discussion, the scrum guide provides three questions:

Why is this Sprint valuable?

What can be Done this Sprint?

How will the chosen work get done?<ref name="scrum guide"/>

===Daily Scrum===

As the name suggests, the daily Scrum is a daily event. This is mostly an event only for the developers of the Scrum team. It is a 15-minute meeting where the developers themselves can plan how they want to tackle the sprint backlog, which was made in the sprint planning. For the sake of simplicity, it is highly encouraged that the daily scrum takes place at the same time each day. Whether that is in the beginning of each workday or at the end, is up to the developers to decide. The focus of each meeting should be to plan the next immediate steps and not a long-term plan for the entire sprint.
Since it is often only the developers who participate in the daily Scrum, it encourages self-management and help the developers focus on the tasks at hand.

===Sprint Review===

The sprint review is the last step of the sprint itself. This event includes all Scrum team members as well as other stakeholders. These stakeholders could be people such as, customers/clients, upper management or other people within the scrum team’s organization that is interested in the outcome of the sprint. This group of people is often referred to as the review group. In the sprint review, the developers can demonstrate what they have developed throughout the sprint. However, a good sprint review should not just be a presentation by the developers. The developers should include the review team and encourage a conversation. In ‘The Scrum papers’ Jeff Sutherland writes:
“The review includes a demo of what the Team built during the Sprint, but if the focus of the review is a demo rather than conversation, there is an imbalance.”<ref name="scrum papers"/>

===Sprint Retrospective===

After the sprint is completed is when the Scrum team should perform the sprint retrospective. Here, the team reflects upon the last sprint or older. and discuss what went wrong and what went right. Whereas the sprint review was very focused on the product and whether it fulfilled the product requirements or not, the sprint retrospective is focused on the process or interactions within the sprint. This event is usually facilitated by the Scrum master due to their deep knowledge about the Scrum framework. The main goal of the sprint retrospective is to identify the elements that produced issues or conflicts and try to eliminate them before starting the next sprint. If done correctly, this event can prevent issues and make future sprint more effective.
This event concludes the sprint, and the Scrum team should now be ready to start the planning of the next sprint.

== Scrum Artifacts ==

The Scrum framework includes artifacts, each with their own commitment. These artifacts are essential for the framework and help the Scrum team map their progress.

===Product Backlog===

The product is a list of items or objectives, that is needed for the final product or its improvement. It serves as the main overview of work needed to be done by the Scrum team. The product backlog items, and length relies heavily on the type of product goal. It is important to constantly size the product backlog and improve it by further detailing each item into smaller tasks. This is mainly done by the developers of the Scrum team, but the product owner may assist them by providing insight.
The commitment of the product backlog is the ‘Product goal’. Every single item on the product backlog must be able to be traced back to the product goal. The product goal is the long-term goal of the Scrum team and may take several sprints to finally achieve. A product is a broad term but, in the Scrum guide they define it as the following:
“A product is a vehicle to deliver value. It has a clear boundary, known stakeholders, well-defined users or customers. A product could be a service, a physical product, or something more abstract”<ref name="scrum guide"/>

===Sprint Backlog===

The sprint backlog is developed in the sprint planning event. Here the Scrum team select items from the product backlog, that they wish to complete by the end of the sprint. In order words, the sprint backlog is a sub-list of the product backlog which should be achievable within the sprint timeframe.
The commitment of the sprint backlog is the ‘Sprint goal’. This is very similar to the product goal, but on a smaller scale. As mentioned earlier, every sprint has a clear goal, and just like the items in the product backlog, the items in the sprint backlog should solely serve the purpose of completing the sprint goal.

===Increment===

The last Scrum artifact is the increment. An Increment is a completion of a task which supports the product goal. All increments must be thoroughly tested together to make sure that they all work together. Increments are made within a sprint and are presented in the sprint review but can in some cases be released before the sprint is done.
The commitment of the Increment is the ‘Definition of Done’. The definition of done is a clear definition of when a task is considered done. The definition is made by the developers and must ensure that the standard and requirements are upheld and thereby eliminating the release of faulty or low-quality products.

== Scrum and Agile management ==

Scrum has become synonymous with agile management. Agile is a management style which emphasizes agility and the organization’s ability to quickly react to change in its environment<ref name="intro to agile"/>. Agile management gained popularity in the 2000s after the release of The Agile Manifesto by Martin Fowler and Jim Highsmith in 2001<ref name="manifesto"/>. It started within the software development industry but has become more widespread in recent years. Proponents of agile management were tired of ‘heavy’ models with a lot of documentation and bureaucracy, which made companies slow to react to changes. The software industry saw a fast development of technology which traditional management methods had a tough time of handling. As the authors of The Agile Manifesto puts it:

“Facilitating change is more effective than attempting to prevent it. Learn to trust in your ability to respond to unpredictable events; it's more important than trusting in your ability to plan for disaster.”<ref name="manifesto"/>

Agile practitioners will opt for lighter and simpler management tools, with one of the most popular being the Scrum framework. Scrum was designed to be simple and easily applicable to whatever goal to organization wants to achieve. The paper “Agile Software Development Methods: Review and Analysis” written by Pekka Abrahamsson, Outi Salo, Jussi Ronkainen and Juhani Warsta<ref name="Agile methods"/>, mentions Scrum as a popular agile development method alongside or frameworks such as: Extreme Programming, Feature Driven Development and The Rational Unified Process.

== Limitations of Scrum ==

No methodology is perfect. Scrum, just like any other framework, has some drawbacks. Some organizations have experienced trouble adapting this framework to larger groups. This has led some organizations to develop their own variation of the Scrum framework. One of the most popular alternatives to the Scrum framework is the Spotify model. This model splits the entire organizations into groups which are named; Squads, Tribes, Chapters Guilds etc. (spotify ref).
Scrum also divides responsibility and authority among the team members. This is done to strengthen self-management and engagement. However, this means that if team member is to leave, it can have devasting consequences for the Scrum team. Some people also find it frustrating with the daily meeting, which is a key feature of the Scrum framework.
These drawbacks show why it is important for organizations looking to adopt the Scrum methodology, to understand how it may affect them and possibly make their own adaptations.

== Annotated Bibliography ==
Schwaber, K. and Sutherland, J., 2011. The scrum guide. Scrum Alliance, 21(1)
This guide is essential for people to read if they want to know more about the Scrum framework. It has been cited multiple times in this article because it was written by the very inventors of the Scrum framework as we know it today. They are also responsible of certifying Scrum masters.

The Scrum Papers:, Nut, Bolts, and Origins of an Agile Framework, Scrum, Inc. Jeff Sutherland, 2011
This paper dives further into the history of Scrum and contains a more in-depth guide of its different applications. In addition to this, the paper also provides examples of its implementation. This source is great for people interested in reading more about Scrum.

Abrahamsson, P., Salo, O., Ronkainen, J. and Warsta, J., 2017. Agile software development methods: Review and analysis.<ref name="Agile methods"/>
As mentioned in this article, the Scrum framework is a popular tool within agile management. If one is interested in Agile management, this paper provides an overview of agile management and different tools within Agile management.

=References=

<references>

<ref name="intro to agile">Cohen, D., Lindvall, M. and Costa, P., 2004. An introduction to agile methods. Adv. Comput., 62(03), pp.1-66.</ref>

<ref name="scrum guide"> Schwaber, K. and Sutherland, J., 2011. The scrum guide. Scrum Alliance, 21(1) </ref>

<ref name="scrum papers">The Scrum Papers:, Nut, Bolts, and Origins of an Agile Framework, Scrum, Inc. Jeff Sutherland, 2011</ref>

<ref name="Agile methods"> Abrahamsson, P., Salo, O., Ronkainen, J. and Warsta, J., 2017. Agile software development methods: Review and analysis. </ref>

<ref name="orginal scrum">Takeuchi, H. and Nonaka, I., 1986. The new new product development game. Harvard business review, 64(1), pp.137-146.</ref>

<ref name="workfront">Scrum Product Owner,” Available online: https://www.workfront.com/project-management/methodologies/scrum/product-owner#:~:text=What%20is%20a%20Scrum%20Product,marketplace%2C%20competitors%2C%20and%20trends.
</ref>

<ref name="manifesto">Scrum Product Owner,” Fowler, M. and Highsmith, J., 2001. The agile manifesto. Software development, 9(8), pp.28-35. </ref>

</references>

Scrum 2

2022-03-22T21:14:10Z

S184301: /* References */

== Introduction ==

Scrum was introduced in 1986 by Hirotaka Takeuchi and Ikujiro Nonaka with an article named: ‘The New New Product Development Game’, published by Harvard Business Review<ref name="orginal scrum"/>. In the early 1990s it was further developed by Ken Schwaber and his company. Even though Scrum is spelled in all capital letters a lot of places, it is not an acronym. The word itself originated from rugby, where the term means a formation of players or a team.
Scrum was made to help provide organizations flexible solutions to problems. Scrum is an iterative process, with the time frame most commonly being between 2 weeks and a month. This time frame is called a sprint in Scrum terminology. However, this varies a lot depending on the organization needs.
Scrum has in recent years become a very popular project management framework. It is commonly used in companies who wish to become agile or lean. Together with the Kanban board, the Scrum framework has become an essential tool within agile and lean management.

Within the framework the Scrum Master manages a group through the following steps:

1. A Product Owner orders the work for a complex problem into a Product Backlog.

2. The Scrum Team turns a selection of the work into an Increment of value during a Sprint.

3. The Scrum Team and its stakeholders inspect the results and adjust for the next Sprint.

4. Repeat. <ref name="scrum guide"/>

This article will go through the steps of the Scrum framework and the ideas behind them.

== Values ==
[[File:Scrum values.jpg|400px|right|Fig 1: Scrum.org: Author]]
The Scrum framework is based upon 5 core values that are meant to help illustrate some of benefits of the framework. The five values are:

- Courage

- Focus

- Commitment

- Respect

- Openness

For a Scrum process to be successful, the scrum team must keep these values in mind. The teams must be courageous so that they can use this framework to solve tough and complex issues. Focus and Commitment are also essential. When working with complex issues it is important that the team participating in the process are focused and committed. Finally, this framework is used by teams of people and therefore the participants are forced to work together. To help ensure conflicts are avoided, participants are encouraged to be respectful and open towards their fellow teammates.

== Team ==
As mentioned before, the Scrum is performed by a small team of people. A Scrum team consists of a Product owner, a Scrum master and developers. The Scrum team is supposed to be self-managed and consisting of people with the necessary competences to achieve the goal. In order words, the teams should not be relying on any other manager or employees. The Scrum team can vary in size, however, smaller teams are preferable since it helps the team stay nimble and agile. According to the Scrum Guide<ref name="scrum guide"/>, a Scrum team should rarely exceed 10 people, but it does of course depend on the objective or goal of the organization.

===Developers===
One part of the Scrum team is Developers. Ken Scwaber and Jeff Sutherland describes developers as follows in their Scrum Guide: “Developers are the people in the Scrum Team that are committed to creating any aspect of a usable Increment each Sprint.”<ref name="scrum guide"/>. In addition to that, they are responsible for making the product at the end of each sprint. You do not need any specific skill in order to become a Developer, since the skill requirement relies heavily on the objective. The competences and background of the Developers varies a lot, however, there are a few characteristics most great Developers should possess, for example, the ability to work together in teams. However, according to the Scrum guide developers are always responsible for:

• Creating a plan for the Sprint, the Sprint Backlog

• Instilling quality by adhering to a Definition of Done

• Adapting their plan each day toward the Sprint Goal; and,

• Holding each other accountable as professionals. <ref name="scrum guide"/>

===Product Owners===
The product owner is often the key stakeholder of the project<ref name="workfront"/>. Their main purpose is ensuring the maximization of the value that the project intends to provide to the end customer. They do this by managing the product backlog which is an ordered list of the desired features the end product should have.

Product owners often takes the perspective of the customer or consumer of the product. This customer centric perspective is meant to help ensure that the product actually delivers on the goals set in the beginning of the process. The product owner is the role within the Scrum framework that acts the most like what a project manager does in a traditional project group. It is fine for a product owner delegate work within the Scrum team, but the product owner is accountable of not only the daily executions of Scrum events but also the final product. A product owner is often a person with knowledge of both the business and technical side of the project and can therefore act as a mediator between developers with different backgrounds. It is also recommended that the product owner is someone with great leadership since the person is in charge of the entire Scrum team and the process. The Scrum guide also emphasizes the importance of their only being one single person as product owner within every Scrum team: “The Product Owner is one person, not a committee. The Product Owner may represent the needs of many stakeholders in the Product Backlog. Those wanting to change the Product Backlog can do so by trying to convince the Product Owner.”<ref name="scrum guide"/>. This also means that, in order for a product owner to be successful, the other members of the Scrum team must trust and respect the product owner decisions.

The product owners key responsibilities can be summed up as follows:

- Defining the vision

- Prioritizing the product backlog

- Taking an overview of development stages

- Handling communications

- Knowing what the client needs

- Evaluating progress <ref name="workfront"/>

===Scrum Master===

In short, the Scrum master is responsible for the Scrum team’s effectiveness. A Scrum master is someone with a deep understanding and knowledge of the Scrum framework. This includes Scrum team roles, Scrum events and Scrum artifacts. One of the main responsibilities of the Scrum master is to make sure every participant understands the Scrum process and their individual roles and responsibilities. In addition to that, the Scrum master also helps outside of their respective scrum team. They can also help the organization around the Scrum team to have a better understanding of how the framework works. The Scrum master thereby serves the Scrum team, the product owner and the organization in numerous ways. They help team members with self-management and ensuring all of the events are done within the set timeframe. They help product owners with planning and backlog management, and finally they help the entire organization by educating and training employees in the Scrum framework.
In order to become an official Scrum master, you have to take a Scrum master certification course. There are many providers of these courses, and they vary in length.

== Scrum events ==

The entire Scrum framework is built around Scrum events. These events are: The sprint, sprint planning, daily Scrum, sprint review and finally sprint retrospective.
[[File:Scrum Sprint.jpg|600px|right|Fig 2: Wrike.com: Author]]
===The Sprint===

The sprint is the most essential scrum event. It is through this process that the goal of the entire Scrum framework is achieved. As with other events within the framework, the duration varies. The duration of the sprint depends on the organization and the goal of the framework. However, it is recommended that the sprints duration is at least under a month. It is also recommended that sprints remain the duration, or at least as close as possible, to help create stability and consistency.
The sprint consists of multiple events, such as Sprint Planning, Daily Scrum, Sprint Review and finally Sprint Retrospective.

===Sprint Planning===

Sprint planning is the very first step of the sprint and kicks off the process. Before starting the sprint a clear goal needs to be set. In this event, the Scrum team has a discussion, facilitated by the product owner, about which items from the product backlog should be included in this sprints sprint backlog. When choosing the sprint goals, it is important to consider that they must be achievable within one sprint and how to actually reach them. To help with this discussion, the scrum guide provides three questions:

Why is this Sprint valuable?

What can be Done this Sprint?

How will the chosen work get done?<ref name="scrum guide"/>

===Daily Scrum===

As the name suggests, the daily Scrum is a daily event. This is mostly an event only for the developers of the Scrum team. It is a 15-minute meeting where the developers themselves can plan how they want to tackle the sprint backlog, which was made in the sprint planning. For the sake of simplicity, it is highly encouraged that the daily scrum takes place at the same time each day. Whether that is in the beginning of each workday or at the end, is up to the developers to decide. The focus of each meeting should be to plan the next immediate steps and not a long-term plan for the entire sprint.
Since it is often only the developers who participate in the daily Scrum, it encourages self-management and help the developers focus on the tasks at hand.

===Sprint Review===

The sprint review is the last step of the sprint itself. This event includes all Scrum team members as well as other stakeholders. These stakeholders could be people such as, customers/clients, upper management or other people within the scrum team’s organization that is interested in the outcome of the sprint. This group of people is often referred to as the review group. In the sprint review, the developers can demonstrate what they have developed throughout the sprint. However, a good sprint review should not just be a presentation by the developers. The developers should include the review team and encourage a conversation. In ‘The Scrum papers’ Jeff Sutherland writes:
“The review includes a demo of what the Team built during the Sprint, but if the focus of the review is a demo rather than conversation, there is an imbalance.”<ref name="scrum papers"/>

===Sprint Retrospective===

After the sprint is completed is when the Scrum team should perform the sprint retrospective. Here, the team reflects upon the last sprint or older. and discuss what went wrong and what went right. Whereas the sprint review was very focused on the product and whether it fulfilled the product requirements or not, the sprint retrospective is focused on the process or interactions within the sprint. This event is usually facilitated by the Scrum master due to their deep knowledge about the Scrum framework. The main goal of the sprint retrospective is to identify the elements that produced issues or conflicts and try to eliminate them before starting the next sprint. If done correctly, this event can prevent issues and make future sprint more effective.
This event concludes the sprint, and the Scrum team should now be ready to start the planning of the next sprint.

== Scrum Artifacts ==

The Scrum framework includes artifacts, each with their own commitment. These artifacts are essential for the framework and help the Scrum team map their progress.

===Product Backlog===

The product is a list of items or objectives, that is needed for the final product or its improvement. It serves as the main overview of work needed to be done by the Scrum team. The product backlog items, and length relies heavily on the type of product goal. It is important to constantly size the product backlog and improve it by further detailing each item into smaller tasks. This is mainly done by the developers of the Scrum team, but the product owner may assist them by providing insight.
The commitment of the product backlog is the ‘Product goal’. Every single item on the product backlog must be able to be traced back to the product goal. The product goal is the long-term goal of the Scrum team and may take several sprints to finally achieve. A product is a broad term but, in the Scrum guide they define it as the following:
“A product is a vehicle to deliver value. It has a clear boundary, known stakeholders, well-defined users or customers. A product could be a service, a physical product, or something more abstract”<ref name="scrum guide"/>

===Sprint Backlog===

The sprint backlog is developed in the sprint planning event. Here the Scrum team select items from the product backlog, that they wish to complete by the end of the sprint. In order words, the sprint backlog is a sub-list of the product backlog which should be achievable within the sprint timeframe.
The commitment of the sprint backlog is the ‘Sprint goal’. This is very similar to the product goal, but on a smaller scale. As mentioned earlier, every sprint has a clear goal, and just like the items in the product backlog, the items in the sprint backlog should solely serve the purpose of completing the sprint goal.

===Increment===

The last Scrum artifact is the increment. An Increment is a completion of a task which supports the product goal. All increments must be thoroughly tested together to make sure that they all work together. Increments are made within a sprint and are presented in the sprint review but can in some cases be released before the sprint is done.
The commitment of the Increment is the ‘Definition of Done’. The definition of done is a clear definition of when a task is considered done. The definition is made by the developers and must ensure that the standard and requirements are upheld and thereby eliminating the release of faulty or low-quality products.

== Scrum and Agile management ==

Scrum has become synonymous with agile management. Agile is a management style which emphasizes agility and the organization’s ability to quickly react to change in its environment<ref name="intro to agile"/>. Agile management gained popularity in the 2000s after the release of The Agile Manifesto by Martin Fowler and Jim Highsmith in 2001<ref name="manifesto"/>. It started within the software development industry but has become more widespread in recent years. Proponents of agile management were tired of ‘heavy’ models with a lot of documentation and bureaucracy, which made companies slow to react to changes. The software industry saw a fast development of technology which traditional management methods had a tough time of handling. As the authors of The Agile Manifesto puts it:

“Facilitating change is more effective than attempting to prevent it. Learn to trust in your ability to respond to unpredictable events; it's more important than trusting in your ability to plan for disaster.”<ref name="manifesto"/>

Agile practitioners will opt for lighter and simpler management tools, with one of the most popular being the Scrum framework. Scrum was designed to be simple and easily applicable to whatever goal to organization wants to achieve. The paper “Agile Software Development Methods: Review and Analysis” written by Pekka Abrahamsson, Outi Salo, Jussi Ronkainen and Juhani Warsta<ref name="Agile methods"/>, mentions Scrum as a popular agile development method alongside or frameworks such as: Extreme Programming, Feature Driven Development and The Rational Unified Process.

== Limitations of Scrum ==

No methodology is perfect. Scrum, just like any other framework, has some drawbacks. Some organizations have experienced trouble adapting this framework to larger groups. This has led some organizations to develop their own variation of the Scrum framework. One of the most popular alternatives to the Scrum framework is the Spotify model. This model splits the entire organizations into groups which are named; Squads, Tribes, Chapters Guilds etc. (spotify ref).
Scrum also divides responsibility and authority among the team members. This is done to strengthen self-management and engagement. However, this means that if team member is to leave, it can have devasting consequences for the Scrum team. Some people also find it frustrating with the daily meeting, which is a key feature of the Scrum framework.
These drawbacks show why it is important for organizations looking to adopt the Scrum methodology, to understand how it may affect them and possibly make their own adaptations.

== Annotated Bibliography ==
Schwaber, K. and Sutherland, J., 2011. The scrum guide. Scrum Alliance, 21(1)
This guide is essential for people to read if they want to know more about the Scrum framework. It has been cited multiple times in this article because it was written by the very inventors of the Scrum framework as we know it today. They are also responsible of certifying Scrum masters.

The Scrum Papers:, Nut, Bolts, and Origins of an Agile Framework, Scrum, Inc. Jeff Sutherland, 2011
This paper dives further into the history of Scrum and contains a more in-depth guide of its different applications. In addition to this, the paper also provides examples of its implementation. This source is great for people interested in reading more about Scrum.

Abrahamsson, P., Salo, O., Ronkainen, J. and Warsta, J., 2017. Agile software development methods: Review and analysis.<ref name="Agile methods"/>
As mentioned in this article, the Scrum framework is a popular tool within agile management. If one is interested in Agile management, this paper provides an overview of agile management and different tools within Agile management.

=References=

</references>

<ref name="intro to agile">Cohen, D., Lindvall, M. and Costa, P., 2004. An introduction to agile methods. Adv. Comput., 62(03), pp.1-66.</ref>

<ref name="scrum guide"> Schwaber, K. and Sutherland, J., 2011. The scrum guide. Scrum Alliance, 21(1) </ref>

<ref name="scrum papers">The Scrum Papers:, Nut, Bolts, and Origins of an Agile Framework, Scrum, Inc. Jeff Sutherland, 2011</ref>

<ref name="Agile methods"> Abrahamsson, P., Salo, O., Ronkainen, J. and Warsta, J., 2017. Agile software development methods: Review and analysis. </ref>

<ref name="orginal scrum">Takeuchi, H. and Nonaka, I., 1986. The new new product development game. Harvard business review, 64(1), pp.137-146./ref>

<ref name="workfront">Scrum Product Owner,” Available online: https://www.workfront.com/project-management/methodologies/scrum/product-owner#:~:text=What%20is%20a%20Scrum%20Product,marketplace%2C%20competitors%2C%20and%20trends.
</ref>

<ref name="manifesto">Scrum Product Owner,” Fowler, M. and Highsmith, J., 2001. The agile manifesto. Software development, 9(8), pp.28-35.
</ref>

</references>

Project Cost Estimation Methods

2022-03-22T19:18:38Z

S184301: /* About Cost Estimation */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management, since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is usually estimated at the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the timetable of the project <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply put, the budget of a project is essential for its success. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available such as analogous estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article, different kinds of cost estimating techniques will be examined, to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article mainly provides a discussion of when to use a selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further research through the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kinds of cost estimates are usually stated in monetary terms, to enable comparisons across projects. They can however also be stated in alternative units, such as staff hours or staff days, if the monetary values are not appropriate or relevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is often times one of the most essential things in order to gain approval from upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates typically increase in accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier. In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility to asses early on whether to proceed with the project or not. According to PMBOK, the accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used in this situation<ref name="three"/>.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. In this kind of situation, it can assist in finding a preliminary cost and budget strategy that is more accurate than that of the ROM, as it has a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise type of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is referred to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are typically "carried out periodically during the duration of the project" according to PMBOK <ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity, rather than a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is that the controlling indicators of the project indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of project managers cost estimations techniques is influenced by a number of factors. This includes the size and scope of the project, the availability of data from previous projects, and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for completing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The type and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when completing estimates without having a lot of available information. Comparable estimates are used when a project has access to previous data on similar types of work, but lacks the specifics and resources for more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however be achieved more easily by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

Parametric estimating is a statistical approach for determining the cost, budget or duration required to complete a project, an activity, or a portion of a project. It uses a relationship between variables (a unit cost/duration and the number of units) to provide an accurate estimate. The size of the present project is then scaled in accordance with the observed association. For instance, in the construction of a highway, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
Like analogous estimating, parametric estimating requires historical data, but it differs from analogous estimating in its algorithmic approach and its use of additional quantitative parameters. At the same time, it accounts for the difference between new and old data. Depending on the level of underlying data built into the model, a high accuracy can be achieved.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the type of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data. Estimates are often times performed by a top-down estimation approach.

* Dividing the project into smaller tasks through the use of a WBS, and asking the people in charge of different tasks of the project to create estimates for how much time and how many resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|350px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation technique provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In the case of analogous estimation, it is applicable at the very basic level of the project, and it does not provide the most precise estimates. It is more appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in the preparation of the model and gathering historical data from past projects to apply to current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate is based on the sum of the activities of the project. It ignores the additional effort required for integrating the activities, while executing the enterprise and complex projects. Furthermore, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages, as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire experts as consultants. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

Different techniques for cost estimation, as well as when to apply them, have been reviewed in this article. ROM estimates are typically the only kind of estimation available at the start phase of a project, resulting in the analogous estimation and expert judgment most commonly being applied here. As a project progresses, the degree of information and data tend to rise and become more accurate, and the ROM can be replaced by budget estimates, followed by definite estimates. As Bottom-up, parametric and three-point estimation methods generally produce the most precise cost estimates, they are frequently required for definitive estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling. However it is worth noting that all methods have their limitations, and producing an exact cost estimate can be very difficult and sometimes close to impossible.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/estimating-project-cost/#2-rough-order-of-magnitude-vs-definitive-estimate</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T19:18:23Z

S184301: /* About Cost Estimation */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management, since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is usually estimated at the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the timetable of the project <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply put, the budget of a project is essential for its success. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available such as analogous estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article, different kinds of cost estimating techniques will be examined, to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article mainly provides a discussion of when to use a selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further research through the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kinds of cost estimates are usually stated in monetary terms, to enable comparisons across projects. They can however also be stated in alternative units, such as staff hours or staff days, if the monetary values are not appropriate or relevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is often times one of the most essential things in order to gain approval from upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates typically increase in accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier. In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility to asses early on whether to proceed with the project or not. According to PMBOK, the accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used in this situation<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. In this kind of situation, it can assist in finding a preliminary cost and budget strategy that is more accurate than that of the ROM, as it has a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise type of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is referred to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are typically "carried out periodically during the duration of the project" according to PMBOK <ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity, rather than a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is that the controlling indicators of the project indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of project managers cost estimations techniques is influenced by a number of factors. This includes the size and scope of the project, the availability of data from previous projects, and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for completing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The type and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when completing estimates without having a lot of available information. Comparable estimates are used when a project has access to previous data on similar types of work, but lacks the specifics and resources for more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however be achieved more easily by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

Parametric estimating is a statistical approach for determining the cost, budget or duration required to complete a project, an activity, or a portion of a project. It uses a relationship between variables (a unit cost/duration and the number of units) to provide an accurate estimate. The size of the present project is then scaled in accordance with the observed association. For instance, in the construction of a highway, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
Like analogous estimating, parametric estimating requires historical data, but it differs from analogous estimating in its algorithmic approach and its use of additional quantitative parameters. At the same time, it accounts for the difference between new and old data. Depending on the level of underlying data built into the model, a high accuracy can be achieved.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the type of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data. Estimates are often times performed by a top-down estimation approach.

* Dividing the project into smaller tasks through the use of a WBS, and asking the people in charge of different tasks of the project to create estimates for how much time and how many resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|350px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation technique provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In the case of analogous estimation, it is applicable at the very basic level of the project, and it does not provide the most precise estimates. It is more appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in the preparation of the model and gathering historical data from past projects to apply to current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate is based on the sum of the activities of the project. It ignores the additional effort required for integrating the activities, while executing the enterprise and complex projects. Furthermore, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages, as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire experts as consultants. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

Different techniques for cost estimation, as well as when to apply them, have been reviewed in this article. ROM estimates are typically the only kind of estimation available at the start phase of a project, resulting in the analogous estimation and expert judgment most commonly being applied here. As a project progresses, the degree of information and data tend to rise and become more accurate, and the ROM can be replaced by budget estimates, followed by definite estimates. As Bottom-up, parametric and three-point estimation methods generally produce the most precise cost estimates, they are frequently required for definitive estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling. However it is worth noting that all methods have their limitations, and producing an exact cost estimate can be very difficult and sometimes close to impossible.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/estimating-project-cost/#2-rough-order-of-magnitude-vs-definitive-estimate</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T19:17:47Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management, since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is usually estimated at the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the timetable of the project <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply put, the budget of a project is essential for its success. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available such as analogous estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article, different kinds of cost estimating techniques will be examined, to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article mainly provides a discussion of when to use a selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further research through the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kinds of cost estimates are usually stated in monetary terms, to enable comparisons across projects. They can however also be stated in alternative units, such as staff hours or staff days, if the monetary values are not appropriate or relevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is often times one of the most essential things in order to gain approval from upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates typically increase in accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier. In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility to asses early on whether to proceed with the project or not. According to PMBOK, the accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used in this situation<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. In this kind of situation, it can assist in finding a preliminary cost and budget strategy that is more accurate than that of the ROM, as it has a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise type of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is referred to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are typically "carried out periodically during the duration of the project" according to PMBOK <ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity, rather than a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is that the controlling indicators of the project indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of project managers cost estimations techniques is influenced by a number of factors. This includes the size and scope of the project, the availability of data from previous projects, and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for completing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The type and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when completing estimates without having a lot of available information. Comparable estimates are used when a project has access to previous data on similar types of work, but lacks the specifics and resources for more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however be achieved more easily by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

Parametric estimating is a statistical approach for determining the cost, budget or duration required to complete a project, an activity, or a portion of a project. It uses a relationship between variables (a unit cost/duration and the number of units) to provide an accurate estimate. The size of the present project is then scaled in accordance with the observed association. For instance, in the construction of a highway, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
Like analogous estimating, parametric estimating requires historical data, but it differs from analogous estimating in its algorithmic approach and its use of additional quantitative parameters. At the same time, it accounts for the difference between new and old data. Depending on the level of underlying data built into the model, a high accuracy can be achieved.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the type of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data. Estimates are often times performed by a top-down estimation approach.

* Dividing the project into smaller tasks through the use of a WBS, and asking the people in charge of different tasks of the project to create estimates for how much time and how many resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|350px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation technique provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In the case of analogous estimation, it is applicable at the very basic level of the project, and it does not provide the most precise estimates. It is more appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in the preparation of the model and gathering historical data from past projects to apply to current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate is based on the sum of the activities of the project. It ignores the additional effort required for integrating the activities, while executing the enterprise and complex projects. Furthermore, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages, as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire experts as consultants. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

Different techniques for cost estimation, as well as when to apply them, have been reviewed in this article. ROM estimates are typically the only kind of estimation available at the start phase of a project, resulting in the analogous estimation and expert judgment most commonly being applied here. As a project progresses, the degree of information and data tend to rise and become more accurate, and the ROM can be replaced by budget estimates, followed by definite estimates. As Bottom-up, parametric and three-point estimation methods generally produce the most precise cost estimates, they are frequently required for definitive estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling. However it is worth noting that all methods have their limitations, and producing an exact cost estimate can be very difficult and sometimes close to impossible.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/estimating-project-cost/#2-rough-order-of-magnitude-vs-definitive-estimate</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T19:12:01Z

S184301: /* Abstract */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management, since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is usually estimated at the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the timetable of the project <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply put, the budget of a project is essential for its success. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available such as analogous estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article, different kinds of cost estimating techniques will be examined, to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article mainly provides a discussion of when to use a selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further research through the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kinds of cost estimates are usually stated in monetary terms, to enable comparisons across projects. They can however also be stated in alternative units, such as staff hours or staff days, if the monetary values are not appropriate or relevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is often times one of the most essential things in order to gain approval from upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates typically increase in accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier. In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility to asses early on whether to proceed with the project or not. According to PMBOK, the accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used in this situation<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. In this kind of situation, it can assist in finding a preliminary cost and budget strategy that is more accurate than that of the ROM, as it has a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise type of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is referred to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are typically "carried out periodically during the duration of the project" according to PMBOK <ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity, rather than a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is that the controlling indicators of the project indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of project managers cost estimations techniques is influenced by a number of factors. This includes the size and scope of the project, the availability of data from previous projects, and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for completing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The type and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when completing estimates without having a lot of available information. Comparable estimates are used when a project has access to previous data on similar types of work, but lacks the specifics and resources for more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however be achieved more easily by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

Parametric estimating is a statistical approach for determining the cost, budget or duration required to complete a project, an activity, or a portion of a project. It uses a relationship between variables (a unit cost/duration and the number of units) to provide an accurate estimate. The size of the present project is then scaled in accordance with the observed association. For instance, in the construction of a highway, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
Like analogous estimating, parametric estimating requires historical data, but it differs from analogous estimating in its algorithmic approach and its use of additional quantitative parameters. At the same time, it accounts for the difference between new and old data. Depending on the level of underlying data built into the model, a high accuracy can be achieved.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the type of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data. Estimates are often times performed by a top-down estimation approach.

* Dividing the project into smaller tasks through the use of a WBS, and asking the people in charge of different tasks of the project to create estimates for how much time and how many resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation technique provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In the case of analogous estimation, it is applicable at the very basic level of the project, and it does not provide the most precise estimates. It is more appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in the preparation of the model and gathering historical data from past projects to apply to current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate is based on the sum of the activities of the project. It ignores the additional effort required for integrating the activities, while executing the enterprise and complex projects. Furthermore, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages, as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire experts as consultants. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

Different techniques for cost estimation, as well as when to apply them, have been reviewed in this article. ROM estimates are typically the only kind of estimation available at the start phase of a project, resulting in the analogous estimation and expert judgment most commonly being applied here. As a project progresses, the degree of information and data tend to rise and become more accurate, and the ROM can be replaced by budget estimates, followed by definite estimates. As Bottom-up, parametric and three-point estimation methods generally produce the most precise cost estimates, they are frequently required for definitive estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling. However it is worth noting that all methods have their limitations, and producing an exact cost estimate can be very difficult and sometimes close to impossible.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/estimating-project-cost/#2-rough-order-of-magnitude-vs-definitive-estimate</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T19:06:01Z

S184301: /* Limitations */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management, since it is used to calculate and manage the project budget is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is usually estimated at the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the timetable of the project <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply put, the budget of a project is essential for its success. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available such as analogous estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article, different kinds of cost estimating techniques will be examined, to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article mainly provides a discussion of when to use a selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further research through the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kinds of cost estimates are usually stated in monetary terms, to enable comparisons across projects. They can however also be stated in alternative units, such as staff hours or staff days, if the monetary values are not appropriate or relevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is often times one of the most essential things in order to gain approval from upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates typically increase in accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier. In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility to asses early on whether to proceed with the project or not. According to PMBOK, the accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used in this situation<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. In this kind of situation, it can assist in finding a preliminary cost and budget strategy that is more accurate than that of the ROM, as it has a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise type of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is referred to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are typically "carried out periodically during the duration of the project" according to PMBOK <ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity, rather than a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is that the controlling indicators of the project indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of project managers cost estimations techniques is influenced by a number of factors. This includes the size and scope of the project, the availability of data from previous projects, and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for completing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The type and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when completing estimates without having a lot of available information. Comparable estimates are used when a project has access to previous data on similar types of work, but lacks the specifics and resources for more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however be achieved more easily by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

Parametric estimating is a statistical approach for determining the cost, budget or duration required to complete a project, an activity, or a portion of a project. It uses a relationship between variables (a unit cost/duration and the number of units) to provide an accurate estimate. The size of the present project is then scaled in accordance with the observed association. For instance, in the construction of a highway, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
Like analogous estimating, parametric estimating requires historical data, but it differs from analogous estimating in its algorithmic approach and its use of additional quantitative parameters. At the same time, it accounts for the difference between new and old data. Depending on the level of underlying data built into the model, a high accuracy can be achieved.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the type of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data. Estimates are often times performed by a top-down estimation approach.

* Dividing the project into smaller tasks through the use of a WBS, and asking the people in charge of different tasks of the project to create estimates for how much time and how many resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation technique provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In the case of analogous estimation, it is applicable at the very basic level of the project, and it does not provide the most precise estimates. It is more appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in the preparation of the model and gathering historical data from past projects to apply to current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate is based on the sum of the activities of the project. It ignores the additional effort required for integrating the activities, while executing the enterprise and complex projects. Furthermore, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages, as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire experts as consultants. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

Different techniques for cost estimation, as well as when to apply them, have been reviewed in this article. ROM estimates are typically the only kind of estimation available at the start phase of a project, resulting in the analogous estimation and expert judgment most commonly being applied here. As a project progresses, the degree of information and data tend to rise and become more accurate, and the ROM can be replaced by budget estimates, followed by definite estimates. As Bottom-up, parametric and three-point estimation methods generally produce the most precise cost estimates, they are frequently required for definitive estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling. However it is worth noting that all methods have their limitations, and producing an exact cost estimate can be very difficult and sometimes close to impossible.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/estimating-project-cost/#2-rough-order-of-magnitude-vs-definitive-estimate</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T19:02:28Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management, since it is used to calculate and manage the project budget is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is usually estimated at the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the timetable of the project <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply put, the budget of a project is essential for its success. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available such as analogous estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article, different kinds of cost estimating techniques will be examined, to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article mainly provides a discussion of when to use a selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further research through the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kinds of cost estimates are usually stated in monetary terms, to enable comparisons across projects. They can however also be stated in alternative units, such as staff hours or staff days, if the monetary values are not appropriate or relevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is often times one of the most essential things in order to gain approval from upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates typically increase in accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier. In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility to asses early on whether to proceed with the project or not. According to PMBOK, the accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used in this situation<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. In this kind of situation, it can assist in finding a preliminary cost and budget strategy that is more accurate than that of the ROM, as it has a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise type of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is referred to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are typically "carried out periodically during the duration of the project" according to PMBOK <ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity, rather than a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is that the controlling indicators of the project indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of project managers cost estimations techniques is influenced by a number of factors. This includes the size and scope of the project, the availability of data from previous projects, and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for completing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The type and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when completing estimates without having a lot of available information. Comparable estimates are used when a project has access to previous data on similar types of work, but lacks the specifics and resources for more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however be achieved more easily by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

Parametric estimating is a statistical approach for determining the cost, budget or duration required to complete a project, an activity, or a portion of a project. It uses a relationship between variables (a unit cost/duration and the number of units) to provide an accurate estimate. The size of the present project is then scaled in accordance with the observed association. For instance, in the construction of a highway, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
Like analogous estimating, parametric estimating requires historical data, but it differs from analogous estimating in its algorithmic approach and its use of additional quantitative parameters. At the same time, it accounts for the difference between new and old data. Depending on the level of underlying data built into the model, a high accuracy can be achieved.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the type of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data. Estimates are often times performed by a top-down estimation approach.

* Dividing the project into smaller tasks through the use of a WBS, and asking the people in charge of different tasks of the project to create estimates for how much time and how many resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation techniques provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

Different techniques for cost estimation, as well as when to apply them, have been reviewed in this article. ROM estimates are typically the only kind of estimation available at the start phase of a project, resulting in the analogous estimation and expert judgment most commonly being applied here. As a project progresses, the degree of information and data tend to rise and become more accurate, and the ROM can be replaced by budget estimates, followed by definite estimates. As Bottom-up, parametric and three-point estimation methods generally produce the most precise cost estimates, they are frequently required for definitive estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling. However it is worth noting that all methods have their limitations, and producing an exact cost estimate can be very difficult and sometimes close to impossible.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/estimating-project-cost/#2-rough-order-of-magnitude-vs-definitive-estimate</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T18:56:52Z

S184301: /* About Cost Estimation */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management, since it is used to calculate and manage the project budget is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is usually estimated at the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the timetable of the project <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply put, the budget of a project is essential for its success. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available such as analogous estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article, different kinds of cost estimating techniques will be examined, to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article mainly provides a discussion of when to use a selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further research through the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kinds of cost estimates are usually stated in monetary terms, to enable comparisons across projects. They can however also be stated in alternative units, such as staff hours or staff days, if the monetary values are not appropriate or relevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is often times one of the most essential things in order to gain approval from upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates typically increase in accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier. In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility to asses early on whether to proceed with the project or not. According to PMBOK, the accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used in this situation<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. In this kind of situation, it can assist in finding a preliminary cost and budget strategy that is more accurate than that of the ROM, as it has a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise type of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is referred to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are typically "carried out periodically during the duration of the project" according to PMBOK <ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity, rather than a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is that the controlling indicators of the project indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

Parametric estimating is a statistical approach for determining the cost, budget or duration required to complete a project, an activity, or a portion of a project. It uses a relationship between variables (a unit cost/duration and the number of units) to provide an accurate estimate. The size of the present project is then scaled in accordance with the observed association. For instance, in the construction of a highway, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
Like analogous estimating, parametric estimating requires historical data, but it differs from analogous estimating in its algorithmic approach and its use of additional quantitative parameters. At the same time, it addresses for the difference between new and old data. Depending on the sophistication and underlying data built into the model, a high accuracy can be achieved.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by a top-down estimation approach

* Dividing the project into smaller tasks by the use of a WBS, and asking the people in charge of different tasks of the project, to make an estimate of how much time and resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation techniques provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

Different techniques for cost estimation, as well as when to apply them, have been reviewed in this article. ROM estimates are typically the only kind of estimation available at the start phase of a project, resulting in the analogous estimation and expert judgment most commonly being applied here. As a project progresses, the degree of information and data tend to rise and become more accurate, and the ROM can be replaced by budget estimates, followed by definite estimates. As Bottom-up, parametric and three-point estimation methods generally produce the most precise cost estimates, they are frequently required for definitive estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling. However it is worth noting that all methods have their limitations, and producing an exact cost estimate can be very difficult and sometimes close to impossible.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/estimating-project-cost/#2-rough-order-of-magnitude-vs-definitive-estimate</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T18:51:29Z

S184301: /* Abstract */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management, since it is used to calculate and manage the project budget is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is usually estimated at the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the timetable of the project <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply put, the budget of a project is essential for its success. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available such as analogous estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article, different kinds of cost estimating techniques will be examined, to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article mainly provides a discussion of when to use a selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further research through the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

Parametric estimating is a statistical approach for determining the cost, budget or duration required to complete a project, an activity, or a portion of a project. It uses a relationship between variables (a unit cost/duration and the number of units) to provide an accurate estimate. The size of the present project is then scaled in accordance with the observed association. For instance, in the construction of a highway, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
Like analogous estimating, parametric estimating requires historical data, but it differs from analogous estimating in its algorithmic approach and its use of additional quantitative parameters. At the same time, it addresses for the difference between new and old data. Depending on the sophistication and underlying data built into the model, a high accuracy can be achieved.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by a top-down estimation approach

* Dividing the project into smaller tasks by the use of a WBS, and asking the people in charge of different tasks of the project, to make an estimate of how much time and resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation techniques provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

Different techniques for cost estimation, as well as when to apply them, have been reviewed in this article. ROM estimates are typically the only kind of estimation available at the start phase of a project, resulting in the analogous estimation and expert judgment most commonly being applied here. As a project progresses, the degree of information and data tend to rise and become more accurate, and the ROM can be replaced by budget estimates, followed by definite estimates. As Bottom-up, parametric and three-point estimation methods generally produce the most precise cost estimates, they are frequently required for definitive estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling. However it is worth noting that all methods have their limitations, and producing an exact cost estimate can be very difficult and sometimes close to impossible.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/estimating-project-cost/#2-rough-order-of-magnitude-vs-definitive-estimate</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T17:56:25Z

S184301: /* Cost estimation at different stages */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogous estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

Parametric estimating is a statistical approach for determining the cost, budget or duration required to complete a project, an activity, or a portion of a project. It uses a relationship between variables (a unit cost/duration and the number of units) to provide an accurate estimate. The size of the present project is then scaled in accordance with the observed association. For instance, in the construction of a highway, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
Like analogous estimating, parametric estimating requires historical data, but it differs from analogous estimating in its algorithmic approach and its use of additional quantitative parameters. At the same time, it addresses for the difference between new and old data. Depending on the sophistication and underlying data built into the model, a high accuracy can be achieved.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by a top-down estimation approach

* Dividing the project into smaller tasks by the use of a WBS, and asking the people in charge of different tasks of the project, to make an estimate of how much time and resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation techniques provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

Different techniques for cost estimation, as well as when to apply them, have been reviewed in this article. ROM estimates are typically the only kind of estimation available at the start phase of a project, resulting in the analogous estimation and expert judgment most commonly being applied here. As a project progresses, the degree of information and data tend to rise and become more accurate, and the ROM can be replaced by budget estimates, followed by definite estimates. As Bottom-up, parametric and three-point estimation methods generally produce the most precise cost estimates, they are frequently required for definitive estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling. However it is worth noting that all methods have their limitations, and producing an exact cost estimate can be very difficult and sometimes close to impossible.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/estimating-project-cost/#2-rough-order-of-magnitude-vs-definitive-estimate</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T17:47:57Z

S184301: /* References */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogous estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

Parametric estimating is a statistical approach for determining the cost, budget or duration required to complete a project, an activity, or a portion of a project. It uses a relationship between variables (a unit cost/duration and the number of units) to provide an accurate estimate. The size of the present project is then scaled in accordance with the observed association. For instance, in the construction of a highway, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
Like analogous estimating, parametric estimating requires historical data, but it differs from analogous estimating in its algorithmic approach and its use of additional quantitative parameters. At the same time, it addresses for the difference between new and old data. Depending on the sophistication and underlying data built into the model, a high accuracy can be achieved.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by a top-down estimation approach

* Dividing the project into smaller tasks by the use of a WBS, and asking the people in charge of different tasks of the project, to make an estimate of how much time and resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation techniques provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

Different techniques for cost estimation, as well as when to apply them, have been reviewed in this article. ROM estimates are typically the only kind of estimation available at the start phase of a project, resulting in the analogous estimation and expert judgment most commonly being applied here. As a project progresses, the degree of information and data tend to rise and become more accurate, and the ROM can be replaced by budget estimates, followed by definite estimates. As Bottom-up, parametric and three-point estimation methods generally produce the most precise cost estimates, they are frequently required for definitive estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling. However it is worth noting that all methods have their limitations, and producing an exact cost estimate can be very difficult and sometimes close to impossible.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/estimating-project-cost/#2-rough-order-of-magnitude-vs-definitive-estimate</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T17:40:09Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogous estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

Parametric estimating is a statistical approach for determining the cost, budget or duration required to complete a project, an activity, or a portion of a project. It uses a relationship between variables (a unit cost/duration and the number of units) to provide an accurate estimate. The size of the present project is then scaled in accordance with the observed association. For instance, in the construction of a highway, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
Like analogous estimating, parametric estimating requires historical data, but it differs from analogous estimating in its algorithmic approach and its use of additional quantitative parameters. At the same time, it addresses for the difference between new and old data. Depending on the sophistication and underlying data built into the model, a high accuracy can be achieved.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by a top-down estimation approach

* Dividing the project into smaller tasks by the use of a WBS, and asking the people in charge of different tasks of the project, to make an estimate of how much time and resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation techniques provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

Different techniques for cost estimation, as well as when to apply them, have been reviewed in this article. ROM estimates are typically the only kind of estimation available at the start phase of a project, resulting in the analogous estimation and expert judgment most commonly being applied here. As a project progresses, the degree of information and data tend to rise and become more accurate, and the ROM can be replaced by budget estimates, followed by definite estimates. As Bottom-up, parametric and three-point estimation methods generally produce the most precise cost estimates, they are frequently required for definitive estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling. However it is worth noting that all methods have their limitations, and producing an exact cost estimate can be very difficult and sometimes close to impossible.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T17:38:49Z

S184301: /* Abstract */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogous estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

Parametric estimating is a statistical approach for determining the cost, budget or duration required to complete a project, an activity, or a portion of a project. It uses a relationship between variables (a unit cost/duration and the number of units) to provide an accurate estimate. The size of the present project is then scaled in accordance with the observed association. For instance, in the construction of a highway, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
Like analogous estimating, parametric estimating requires historical data, but it differs from analogous estimating in its algorithmic approach and its use of additional quantitative parameters. At the same time, it addresses for the difference between new and old data. Depending on the sophistication and underlying data built into the model, a high accuracy can be achieved.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by a top-down estimation approach

* Dividing the project into smaller tasks by the use of a WBS, and asking the people in charge of different tasks of the project, to make an estimate of how much time and resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation techniques provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

Different techniques for cost estimation, as well as when to apply them, have been reviewed in this article. ROM estimates are typically the only kind of estimation available at the start phase of a project, resulting in the analogous estimation and expert judgment most commonly being applied here. As a project progresses, the degree of information and data tend to rise and become more accurate, and the ROM can be replaced by budget estimates, followed by definite estimates. As Bottom-up, parametric and three-point estimation methods generally produce the most precise cost estimates, they are frequently required for definitive estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling. However it is worth noting that all methods have their limitations, and producing an exact cost estimate can be very difficult and sometimes close to impossible.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T17:34:44Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

Parametric estimating is a statistical approach for determining the cost, budget or duration required to complete a project, an activity, or a portion of a project. It uses a relationship between variables (a unit cost/duration and the number of units) to provide an accurate estimate. The size of the present project is then scaled in accordance with the observed association. For instance, in the construction of a highway, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
Like analogous estimating, parametric estimating requires historical data, but it differs from analogous estimating in its algorithmic approach and its use of additional quantitative parameters. At the same time, it addresses for the difference between new and old data. Depending on the sophistication and underlying data built into the model, a high accuracy can be achieved.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by a top-down estimation approach

* Dividing the project into smaller tasks by the use of a WBS, and asking the people in charge of different tasks of the project, to make an estimate of how much time and resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation techniques provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

Different techniques for cost estimation, as well as when to apply them, have been reviewed in this article. ROM estimates are typically the only kind of estimation available at the start phase of a project, resulting in the analogous estimation and expert judgment most commonly being applied here. As a project progresses, the degree of information and data tend to rise and become more accurate, and the ROM can be replaced by budget estimates, followed by definite estimates. As Bottom-up, parametric and three-point estimation methods generally produce the most precise cost estimates, they are frequently required for definitive estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling. However it is worth noting that all methods have their limitations, and producing an exact cost estimate can be very difficult and sometimes close to impossible.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T17:14:46Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

Parametric estimating is a statistical approach for determining the amount of cost, budget or duration required to complete a project, an activity, or a portion of a project. Is uses a relationship between variables (a unit cost/duration and the number of units) to provide an accurate estimate. The size of the present project is then scaled in accordance with the observed association. For instance, in the construction of a highway, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
Like analogous estimating, parametric estimating requires historical data, but it differs from analogous estimating in its algorithmic approach and its use of additional quantitative parameters. At the same time, it addresses for the difference between new and old data. Depending on the sophistication and underlying data built into the model, a high accuracy can be achieved.

It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by a top-down estimation approach

* Dividing the project into smaller tasks by the use of a WBS, and asking the people in charge of different tasks of the project, to make an estimate of how much time and resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation techniques provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

Different techniques for cost estimation, as well as when to apply them, have been reviewed in this article. ROM estimates are typically the only kind of estimation available at the start phase of a project, resulting in the analogous estimation and expert judgment most commonly being applied here. As a project progresses, the degree of information and data tend to rise and become more accurate, and the ROM can be replaced by budget estimates, followed by definite estimates. As Bottom-up, parametric and three-point estimation methods generally produce the most precise cost estimates, they are frequently required for definitive estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling. However it is worth noting that all methods have their limitations, and producing an exact cost estimate can be very difficult and sometimes close to impossible.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T17:14:39Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

Parametric estimating is a statistical approach for determining the amount of cost, budget or duration required to complete a project, an activity, or a portion of a project. Is uses a relationship between variables (a unit cost/duration and the number of units) to provide an accurate estimate. The size of the present project is then scaled in accordance with the observed association. For instance, in the construction of a highway, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
Like analogous estimating, parametric estimating requires historical data, but it differs from analogous estimating in its algorithmic approach and its use of additional quantitative parameters. At the same time, it addresses for the difference between new and old data. Depending on the sophistication and underlying data built into the model, a high accuracy can be achieved.

It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by a top-down estimation approach

* Dividing the project into smaller tasks by the use of a WBS, and asking the people in charge of different tasks of the project, to make an estimate of how much time and resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation techniques provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

Different techniques for cost estimation, as well as when to apply them, have been reviewed in this article. ROM estimates are typically the only kind of estimation available at the start phase of a project, resulting in the analogous estimation and expert judgment most commonly being applied here. As a project progresses, the degree of information and data tend to rise and become more accurate, and the ROM can be replaced by budget estimates, followed by definite estimates. As Bottom-up, parametric and three-point estimation methods generally produce the most precise cost estimates, they are frequently required for definitive estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling. However it is worth noting that all methods have their limitations, and producing an exact cost estimate can be very difficult and sometimes close to impossible.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:45:18Z

S184301: /* Conclusion */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by a top-down estimation approach

* Dividing the project into smaller tasks by the use of a WBS, and asking the people in charge of different tasks of the project, to make an estimate of how much time and resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation techniques provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

Different techniques for cost estimation, as well as when to apply them, have been reviewed in this article. ROM estimates are typically the only kind of estimation available at the start phase of a project, resulting in the analogous estimation and expert judgment most commonly being applied here. As a project progresses, the degree of information and data tend to rise and become more accurate, and the ROM can be replaced by budget estimates, followed by definite estimates. As Bottom-up, parametric and three-point estimation methods generally produce the most precise cost estimates, they are frequently required for definitive estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling. However it is worth noting that all methods have their limitations, and producing an exact cost estimate can be very difficult and sometimes close to impossible.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:36:50Z

S184301: /* Comparison of Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by a top-down estimation approach

* Dividing the project into smaller tasks by the use of a WBS, and asking the people in charge of different tasks of the project, to make an estimate of how much time and resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation techniques provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Cost Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:35:38Z

S184301: /* About Cost Estimation */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

===Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by a top-down estimation approach

* Dividing the project into smaller tasks by the use of a WBS, and asking the people in charge of different tasks of the project, to make an estimate of how much time and resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation techniques provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:35:29Z

S184301: /* About Cost Estimation */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

==='Cost estimation at different stages===

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by a top-down estimation approach

* Dividing the project into smaller tasks by the use of a WBS, and asking the people in charge of different tasks of the project, to make an estimate of how much time and resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation techniques provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:33:50Z

S184301: /* Limitations */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

'''Cost estimation at different stages'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by a top-down estimation approach

* Dividing the project into smaller tasks by the use of a WBS, and asking the people in charge of different tasks of the project, to make an estimate of how much time and resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Although the project cost estimation techniques provide a good way of calculating the overall cost of the project, the different techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that, it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in the three-point estimation, there are not any major limitations, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:29:48Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

'''Cost estimation at different stages'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

The precision of this technique is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organisation and the industry <ref name="four"/>.

Expert judgement can be done in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by a top-down estimation approach

* Dividing the project into smaller tasks by the use of a WBS, and asking the people in charge of different tasks of the project, to make an estimate of how much time and resources they think it will take to produce the deliverables that are outlined. It is often times possible to get quite precise findings from this kind of expert judgement.

Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures such as the top-down and bottom-up estimation, which are quite similar to the two approaches just described.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in three-point estimation, there is not any major limitation, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:20:49Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

'''Cost estimation at different stages'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution is calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in three-point estimation, there is not any major limitation, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:20:09Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

'''Cost estimation at different stages'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. In this case, the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in three-point estimation, there is not any major limitation, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:19:34Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

'''Cost estimation at different stages'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in three-point estimation, there is not any major limitation, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:19:17Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

'''Cost estimation at different stages'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in three-point estimation, there is not any major limitation, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:18:18Z

S184301: /* About Cost Estimation */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

'''Cost estimation at different stages'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in three-point estimation, there is not any major limitation, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:17:30Z

S184301: /* About Cost Estimation */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert Judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

'''Cost estimation at different stages'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in three-point estimation, there is not any major limitation, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:16:49Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert Judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectations about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in three-point estimation, there is not any major limitation, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:14:12Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert Judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)_in_Project_Management].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in three-point estimation, there is not any major limitation, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:13:20Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert Judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS) tool[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in three-point estimation, there is not any major limitation, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:08:49Z

S184301: /* About Cost Estimation */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or expert Judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS)[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in three-point estimation, there is not any major limitation, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:08:22Z

S184301: /* About Cost Estimation */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. Analogous/ top-down estimation or Expert Judgment is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the top-down approach, as well as expert judgement<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes bottom-op-, parametric-, & three point estimation<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS)[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in three-point estimation, there is not any major limitation, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:07:20Z

S184301: /* About Cost Estimation */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. The "analogous/ top-down estimation" approach or "Expert Judgment"is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the "top-down" approach, aswell as "expert judgement"<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project. This approach typically includes "bottom-op"-, "parametric"-, & "three point" estimation<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS)[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in three-point estimation, there is not any major limitation, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T16:03:16Z

S184301: /* Conclusion */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. The "top-down" estimation approach is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the "top-down" approach<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS)[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in three-point estimation, there is not any major limitation, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. As a project progresses, the estimates' degree of information and complexity tend to rise and become more accurate. ROM estimates are typically the only kind of estimation available at the start phase and therefore the analogous estimation is most commonly used at the start of a project. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation techniques. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value.This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T15:59:36Z

S184301: /* Limitations */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. The "top-down" estimation approach is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the "top-down" approach<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS)[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. Besides that it can be very time consuming to break down the project into smaller tasks. Expert judgement also has some disadvantages as experts may be prone to downplaying the fact that a task took longer than anticipated in the past. Besides the fact that it is time consuming, expert judgment can be costly as the company sometimes needs to hire an expert from the outside. Lastly, in three-point estimation, there is not any major limitation, but it can be very time consuming to provide an estimate for both the optimistic, pessimistic and most likely scenario.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. It is worth noting that the estimates' degree of information and complexity tends to rise as the project progresses. ROM estimates are typically the only kind of estimation available at the start phase. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation technique. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. The standard deviation is used to account for both the inherent errors and the possible dispersion of estimates. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T15:52:58Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. The "top-down" estimation approach is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the "top-down" approach<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS)[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. On the contrary, expert judgement also has some disadvantages as it is also very expensive and time consuming, as the company needs to hire an expert from the outside in this method. Lastly, in three-point estimation, there is not any major limitation, but it takes a lot of time to provide the estimate for both optimistic, pessimistic and most likely for each task.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. It is worth noting that the estimates' degree of information and complexity tends to rise as the project progresses. ROM estimates are typically the only kind of estimation available at the start phase. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation technique. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. The standard deviation is used to account for both the inherent errors and the possible dispersion of estimates. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T15:51:18Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. The "top-down" estimation approach is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the "top-down" approach<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS)[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)].

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures. Instances include determining if earlier work and the present project are comparable or determining whether revisions to parametric estimation are necessary.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. On the contrary, expert judgement also has some disadvantages as it is also very expensive and time consuming, as the company needs to hire an expert from the outside in this method. Lastly, in three-point estimation, there is not any major limitation, but it takes a lot of time to provide the estimate for both optimistic, pessimistic and most likely for each task.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. It is worth noting that the estimates' degree of information and complexity tends to rise as the project progresses. ROM estimates are typically the only kind of estimation available at the start phase. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation technique. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. The standard deviation is used to account for both the inherent errors and the possible dispersion of estimates. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T15:51:05Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. The "top-down" estimation approach is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the "top-down" approach<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>. This level of detail can however easier be achieved by breaking the project down using a Work Breakdown Structure (WBS)[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)]

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures. Instances include determining if earlier work and the present project are comparable or determining whether revisions to parametric estimation are necessary.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. On the contrary, expert judgement also has some disadvantages as it is also very expensive and time consuming, as the company needs to hire an expert from the outside in this method. Lastly, in three-point estimation, there is not any major limitation, but it takes a lot of time to provide the estimate for both optimistic, pessimistic and most likely for each task.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. It is worth noting that the estimates' degree of information and complexity tends to rise as the project progresses. ROM estimates are typically the only kind of estimation available at the start phase. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation technique. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. The standard deviation is used to account for both the inherent errors and the possible dispersion of estimates. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T15:50:28Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. The "top-down" estimation approach is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the "top-down" approach<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. This level of detail can be achieved by breaking the project down using the Work Breakdown Structure (WBS)[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)]. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask actively involved stakeholders to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>.

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures. Instances include determining if earlier work and the present project are comparable or determining whether revisions to parametric estimation are necessary.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. On the contrary, expert judgement also has some disadvantages as it is also very expensive and time consuming, as the company needs to hire an expert from the outside in this method. Lastly, in three-point estimation, there is not any major limitation, but it takes a lot of time to provide the estimate for both optimistic, pessimistic and most likely for each task.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. It is worth noting that the estimates' degree of information and complexity tends to rise as the project progresses. ROM estimates are typically the only kind of estimation available at the start phase. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation technique. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. The standard deviation is used to account for both the inherent errors and the possible dispersion of estimates. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T15:25:27Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. The "top-down" estimation approach is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the "top-down" approach<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. Is is here important to have a Work Breakdown Structure (WBS)[http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)] in order . The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask those stakeholders who are actively involved in appropriate activities and work packages to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>.

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures. Instances include determining if earlier work and the present project are comparable or determining whether revisions to parametric estimation are necessary.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. On the contrary, expert judgement also has some disadvantages as it is also very expensive and time consuming, as the company needs to hire an expert from the outside in this method. Lastly, in three-point estimation, there is not any major limitation, but it takes a lot of time to provide the estimate for both optimistic, pessimistic and most likely for each task.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. It is worth noting that the estimates' degree of information and complexity tends to rise as the project progresses. ROM estimates are typically the only kind of estimation available at the start phase. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation technique. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. The standard deviation is used to account for both the inherent errors and the possible dispersion of estimates. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T15:25:10Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. The "top-down" estimation approach is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the "top-down" approach<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. Is is here important to have a Work Breakdown Structure (WBS) in order [http://wiki.doing-projects.org/index.php/Work_Breakdown_Structure_(WBS)]. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask those stakeholders who are actively involved in appropriate activities and work packages to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>.

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures. Instances include determining if earlier work and the present project are comparable or determining whether revisions to parametric estimation are necessary.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. On the contrary, expert judgement also has some disadvantages as it is also very expensive and time consuming, as the company needs to hire an expert from the outside in this method. Lastly, in three-point estimation, there is not any major limitation, but it takes a lot of time to provide the estimate for both optimistic, pessimistic and most likely for each task.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. It is worth noting that the estimates' degree of information and complexity tends to rise as the project progresses. ROM estimates are typically the only kind of estimation available at the start phase. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation technique. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. The standard deviation is used to account for both the inherent errors and the possible dispersion of estimates. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T15:14:02Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. The "top-down" estimation approach is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the "top-down" approach<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask those stakeholders who are actively involved in appropriate activities and work packages to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>.

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures. Instances include determining if earlier work and the present project are comparable or determining whether revisions to parametric estimation are necessary.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's i calculated by:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. On the contrary, expert judgement also has some disadvantages as it is also very expensive and time consuming, as the company needs to hire an expert from the outside in this method. Lastly, in three-point estimation, there is not any major limitation, but it takes a lot of time to provide the estimate for both optimistic, pessimistic and most likely for each task.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. It is worth noting that the estimates' degree of information and complexity tends to rise as the project progresses. ROM estimates are typically the only kind of estimation available at the start phase. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation technique. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. The standard deviation is used to account for both the inherent errors and the possible dispersion of estimates. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T15:13:44Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. The "top-down" estimation approach is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the "top-down" approach<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask those stakeholders who are actively involved in appropriate activities and work packages to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>.

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures. Instances include determining if earlier work and the present project are comparable or determining whether revisions to parametric estimation are necessary.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve. The PERT distribution's formula is as follows:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. On the contrary, expert judgement also has some disadvantages as it is also very expensive and time consuming, as the company needs to hire an expert from the outside in this method. Lastly, in three-point estimation, there is not any major limitation, but it takes a lot of time to provide the estimate for both optimistic, pessimistic and most likely for each task.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. It is worth noting that the estimates' degree of information and complexity tends to rise as the project progresses. ROM estimates are typically the only kind of estimation available at the start phase. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation technique. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. The standard deviation is used to account for both the inherent errors and the possible dispersion of estimates. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T15:11:46Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. The "top-down" estimation approach is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the "top-down" approach<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask those stakeholders who are actively involved in appropriate activities and work packages to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>.

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures. Instances include determining if earlier work and the present project are comparable or determining whether revisions to parametric estimation are necessary.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT & Triangular Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve
The PERT distribution's formula is as follows:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. On the contrary, expert judgement also has some disadvantages as it is also very expensive and time consuming, as the company needs to hire an expert from the outside in this method. Lastly, in three-point estimation, there is not any major limitation, but it takes a lot of time to provide the estimate for both optimistic, pessimistic and most likely for each task.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. It is worth noting that the estimates' degree of information and complexity tends to rise as the project progresses. ROM estimates are typically the only kind of estimation available at the start phase. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation technique. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. The standard deviation is used to account for both the inherent errors and the possible dispersion of estimates. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T15:11:20Z

S184301: /* Comparison of Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. The "top-down" estimation approach is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the "top-down" approach<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask those stakeholders who are actively involved in appropriate activities and work packages to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>.

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures. Instances include determining if earlier work and the present project are comparable or determining whether revisions to parametric estimation are necessary.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT, Triangular and Normal Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve
The PERT distribution's formula is as follows:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. On the contrary, expert judgement also has some disadvantages as it is also very expensive and time consuming, as the company needs to hire an expert from the outside in this method. Lastly, in three-point estimation, there is not any major limitation, but it takes a lot of time to provide the estimate for both optimistic, pessimistic and most likely for each task.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="six"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. It is worth noting that the estimates' degree of information and complexity tends to rise as the project progresses. ROM estimates are typically the only kind of estimation available at the start phase. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation technique. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. The standard deviation is used to account for both the inherent errors and the possible dispersion of estimates. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T15:10:59Z

S184301: /* Comparison of Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. The "top-down" estimation approach is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the "top-down" approach<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask those stakeholders who are actively involved in appropriate activities and work packages to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>.

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures. Instances include determining if earlier work and the present project are comparable or determining whether revisions to parametric estimation are necessary.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT, Triangular and Normal Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve
The PERT distribution's formula is as follows:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. On the contrary, expert judgement also has some disadvantages as it is also very expensive and time consuming, as the company needs to hire an expert from the outside in this method. Lastly, in three-point estimation, there is not any major limitation, but it takes a lot of time to provide the estimate for both optimistic, pessimistic and most likely for each task.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data <ref name="three"/> 
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. It is worth noting that the estimates' degree of information and complexity tends to rise as the project progresses. ROM estimates are typically the only kind of estimation available at the start phase. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation technique. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. The standard deviation is used to account for both the inherent errors and the possible dispersion of estimates. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

</references>

Project Cost Estimation Methods

2022-03-22T15:09:43Z

S184301: /* Project Cost Estimation Techniques */

== Abstract ==

Prior to the start of a project, cost estimation is critical. It is an important phase in project management since it is used to calculate and manage the project budget, which is often the most important parameter within the standard success criteria of cost, schedule, and performance targets. The cost of a project is for the first time estimated upon the start of the project or sometimes even before. Afterwards, the cost is re-estimated on a regular basis to account for new information, scope changes, and the project's timetable <ref name="two"/>. The cost of a project has the potential to impact nearly every area of the project, making it one of the most critical jobs for a project manager. A poorly written budget will result in incorrect asset allocation, unrealistic expectations, and, in the worst-case situation, project failure & customer disappointment. Simply said, a project's budget must be accurate for it to succeed. Cost estimation is one of the most helpful tools in a project manager's arsenal for creating an adequate budget. There are different methods of cost estimation available in the literature such as analogue estimation, parametric estimation, bottom up estimation, expert judgement, and three-point estimation. Each method has its own pros and cons for different projects. The application of each cost estimation method varies from project to project and the nature of the project. <ref name="ref1"/> Throughout the article different kind of cost estimating techniques will be examined to determine which approach is most appropriate for different types of projects, as well as different stages of the project.<ref name="budget"/>.

Note that this article only provides a discussion of selection of cost estimation methods. For further insight into the concrete application of these methods, it is recommended to do further reading in the annotated bibliography and references.

== About Cost Estimation ==

A cost estimation is a calculated estimate of the number of resources necessary to accomplish a project or components of a project, which is typically done by dividing the projects into more manageable parts. Cost estimates are used to allocate funding to the deliverables and work packages of the project. These kind of cost estimates are usually stated in monetary terms, to enable comparisons across project. They can however also be stated in alternative units such as staff hours or staff days, if the monetary values are not appropriate or irrelevant. The estimate of project costs is one of the most critical components of project planning and management. The reason for this being that every project relies upon three main components: scope, budget and timeline. Budget is here often times one of the most essential things in order to gain approval of upper management or the person funding the project. The budget is typically very difficult to estimate accurately in the beginning of a project, due to lack of information and data, and estimates are typically increasing im accuracy as the project progresses. Therefore, cost estimation is divided into three different overall categories, according to PMBOK®, which is a set of standard terminology and guidelines for project management <ref name="three"/>:

* Rough order of magnitude (ROM)
* Budget Estimate
* Definitive estimate

All three categories vary in terms of precision, project stages in which they are used, and tools and procedures accessible.

[[File:BudgetImage.png|400px|thumb|right|Figure 1: Estimate Ranges ]]

'''[[Rough Order of Magnitude]]'''

The ROM is a rough numerical estimate or approximation, established at the very early phases of a project when there is not much information available, such as during its inception or even earlier – In the case of the cost-benefit analysis, this would mean during the project selection process. This gives the decision makers the possibility early on to asses whether to proceed with the project or not. According to PMBOK, The accuracy range of ROM is -25 percent to +75 percent. The range was formerly stated as +/-50 percent in prior versions of the PMBOK, such as the 4th edition. As ROM estimations are rather inaccurate because of the wide range of probable results, they are usually replaced by more precise estimates, such as the definitive estimate. The "top-down" estimation approach is most commonly used here<ref name="three"/>.

'''[[Budget Estimate]]'''

The budget estimate is typically applied in the beginning phase of a project, when the final specifications of the project are still unclear, but there is a good understanding of the primary features and technical requirements. It here assists in finding a preliminary cost and budget strategy, that is more accurate than that of the ROM, with a -10 percent to +25 percent accuracy. This approach also most commonly makes use of the "top-down" approach<ref name="seven"/>.

'''[[Definitive Estimate]]'''

The definitive estimate is the PMBOK's most precise sort of estimate. Its precision varies from -5 to +10 percent. This high degree of precision is generally only possible when the project has been meticulously planned and all required information for a credible estimate of the work is available. As a result, definite estimates are often established later in the project. This is often refered to as "Progressive elaboration", here addressing the process of refining preliminary estimations during the life of a project<ref name="three"/>.

'''Different stages of a project'''

As mentioned, costs are calculated at various stages of the project <ref name="ref1"/> and cost estimation procedures are according to PMBOK typically "carried out periodically during the duration of the project"<ref name="three"/>. At the early stage of a project, when the project charter or business case is being prepared, a project manager must identify the resources necessary to finish. Due to the lack of data available at that stage, the project manager is likely to provide a ROM according to the project tasks and its complexity rather than a budget estime or a precise estimate <ref name="three"/>. Although this estimate is not very precise, it gives the stakeholders and project manager a good idea about whether or not to proceed with the project.
As further information becomes available later in the project, the ROM is replaced with a more precise budget estimate, and lastly a definite estimate. Of course this may vary from project to project, and some may skip the budget estimate or start directly with the definite estimate.

Following the project's inception phase, the budget will be reassessed using the approaches described in this article throughout the different phases. Costs are often re-estimated in succeeding stages, as relevant new info and details become available or as the scope of the project or timetable changes. One of the most typical reasons for re-estimating costs is when the project's controlling indicators indicate that the initial budget baseline cannot be fulfilled.

== Project Cost Estimation Techniques ==

The choice of Project managers cost estimations techniques are influenced by a number of factors. This amongst others includes the size and scope of the project, the availability of data from previous projects and the stage which the project is in. Some companies may also require that all projects must be funded in line with strict principles, while others may depend on the project manager's expertise. Many firms tend to depend on estimates in the early stages of project development, rather than more accurate forecasts. All these factors directly influence whether a ROM, a budget estimate or a definite estimate is being made. Five of the most commonly applied techniques for doing such estimates are described in the following section <ref name="three"/>:

'''[[Analogous Estimating]]'''

Analogous estimating, also referred to as top-down estimating, is the process of applying previously observed cost figures and variables to new projects or segments of projects. The kind and structure of the referenced project activities must be similar to the present project in order to ensure accuracy. This method determines the predicted resource needs of a present project by analyzing the past data in terms of numbers and parameters. For the present project, the past values are used, and they may be changed to account for variations in project scope or its complexity. Analogous estimating falls under the category of gross value estimation, as is is often used when doing estimates without having a lot of information available. Comparable estimates are used when a project has access to previous data on similar types of work but lacks the specifics and resources to make more exact estimates <ref name="three"/>.

'''[[Bottom Up Estimating]]'''

Bottom-up estimate is a method for calculating the cost of work units at the lowest possible level of detail. The cost estimates for all project components are then combined to arrive at a total project cost estimate. Generally, these estimations are often made after breaking down the project into smaller work packages and even individual tasks. Whereas there is no specific rule on who should do these estimates, it is typical to ask those stakeholders who are actively involved in appropriate activities and work packages to do so. As a result, the bottom-up estimating technique often produces substantially more accurate results than analogous estimations. Getting these estimates on the lowest level and integrating them, on the other hand, often demands significant resources and may become a political minefield, particularly for big or complicated projects <ref name="three"/>.

'''[[Parametric Estimating]]'''

A statistical approach for determining the projected amount of funds or time required to complete a project, an activity, or a portion of a project is known as parametric estimation. An estimate is calculated using a statistical or ostensible relationship between a group of factors and a cost or time value. The size of the present project is then scaled in accordance with the observed association. For instance, in highway construction, the cost and timing for constructing a mile in a previous project might be used to estimate the resources and timetable for the current project. This, however, requires statistical proof of the association as well as a comparison of the two projects' features <ref name="three"/>.
It is also considered a technique for estimating expenses at various degrees of granularity, the method by which it is implemented differs significantly. Some projects create complicated statistical models and do extensive regression analyses on a variety of variables. They may also create algorithms and provide a large amount of resources to the deployment and testing of such models. This is an approach that can be used for large projects, sometimes known as "large - scale projects," when even minor estimating mistakes can have a huge impact. On the other hand, smaller projects may employ parametric estimate by creating functions or simply using the 'rule of three' if there is proof or a plausible assumption that observable parameters and values correspond. It may also need expert judgement to determine if the predicted regressions are realistic and suitable to the task or the project.

'''[[Expert Judgement]]'''

Expert judgement may be used in both top-down and bottom-up estimation. Its precision is highly dependent on the quantity and expertise of the professionals participating, the understanding of the activities planned and phases, and the kind of project. If the primary stakeholder and team are familiar with the type of work that will be performed on the project, expert judgement may be used to provide an estimate. This involves a working knowledge of the project's topic and its environment, such as the organization and the industry <ref name="four"/>.

Expert judgement may be seen in two ways:
* Estimation of the ROM at the outset of a project. As there are often not many team member at the beginning, and precise estimates are not available due to inexistence of data, estimates are often times performed by top-down estimation approach

* Inquiring the people in charge of the various activities or work packages make an estimate of how much time and resources they think it will take to produce the deliverables outlined in the WBS. It is often times possible to get quite precise findings from this kind of expert judgement.
Expert judgement, in addition to being an estimating approach in and of itself, is also inherent in the other estimation procedures. Instances include determining if earlier work and the present project are comparable or determining whether revisions to parametric estimation are necessary.

'''[[Three-point Estimation]]'''
[[File:TP.png|550px|thumb|right|Figure 2: Probability Density Curves of PERT, Triangular and Normal Distributions <ref name="eight"/>]]

The three-point estimate approach is a simple, but efficient way of evaluating work, time and cost. Three different estimates are employed here, which are usually gathered from experienced specialists:

* ''Most likely estimate''
Realistic expectation about the duration of the different activities, with the resources most likely to be available, as well as potential interruptions etc.

* ''Optimistic estimate''
The amount of work or time necessary to perform a job under ideal circumstances in the most likely estimate. It illustrates what is referred to as the "best-case scenario".

* ''Pessimistic estimate''
The amount of work or time necessary to perform a job under the least ideal circumstances in the most likely estimate. It shows the worst-case scenario.

Both the optimistic and pessimistic estimate are designed to be quite reasonable, despite the fact that they represent the most improbable scenarios<ref name="five"/>.

The Three-point estimation, calculates the final durations or cost numbers in two ways:
* '''The Triangular distribution'''
Takes the average of the three different scenarios and is calculated by:
::::::::::(O + M + P) / 3

* '''The PERT distribution'''
Uses a weighted average, hereby overweighting the ‘most probable' estimate. This means the most likely scenario is assigned a four times higher value then the other scenarios, hereby converting the three-point estimate into a bell-shaped curve
The PERT distribution's formula is as follows:
::::::::::(O + 4⋅M + P) / 6

where:

E = Expected amount of time or cost

O = Optimistic estimate

M = Most likely estimate

P = Pessimistic estimate

The different distributions are illustrated in figure 2

== Limitations ==

Altough the project cost estimation techniques provide a good way of calculating the overall cost of the project, these techniques have some limitations as well. Applications of each techniques varies from project to project and their complexities. In case of analogous estimation, it is applicable at the very basic level of the project and it does not provide the most precise estimates. It is appropriate at initial planning phases of the project rather than in execution phases. On the other hand, Parametric estimation undoubtedly is a more accurate estimation technique, but it consumes more time and resources in preparing the model and gather historical data from the past projects to apply on current project for estimation.

Bottom up estimation also has limitations in certain dimensions, as it does not provide the accurate estimate of the project as its estimate based on the sum of the activities of the project. It ignores the additional effort required of integrating the activities, while executing the enterprise and complex projects. On the contrary, expert judgement also has some disadvantages as it is also very expensive and time consuming, as the company needs to hire an expert from the outside in this method. Lastly, in three-point estimation, there is not any major limitation, but it takes a lot of time to provide the estimate for both optimistic, pessimistic and most likely for each task.

== Comparison of Estimation Techniques ==

{| class="wikitable"
|- style="font-weight:bold;"
! style="font-weight:normal;" | 
! Analogous Estimating
! Bottom-up Estimating
! Parametric Estimating
! Expert Judgment 
! Three-Point Estimating
|-
| style="font-weight:bold;" | Input Data
| Data from previous comparable projects
| Activities & their scope of labour 
| Data from previous comparable projects 
| The professionals' knowledge and experience
| Different techniques for estimating costs
|-
| style="font-weight:bold;" | Method
| Using data of past similar projects & adapting it 
| Estimating costs at the lowest possible detail, then summing up the different components 
| Using data of past projects the present project's cost per parameter unit. 
| Experts provide estimates of the resources required to perform the job within the scope of the project, either from the top-down or from the bottom-up.
| An optimistic, pessimistic, and most probable estimate is produced using one of the four other approaches and are then based on the Pert distribution or triangular converted into a weighted average value .
|-
| style="font-weight:bold;" | Output Type
| Total cost of the project, as well as a cost of each activity 
| Total cost of the project, as well as a cost of each activity
| Total cost of the project, as well as a cost of each activity 
| Varies from each project, but often times several outputs
| Improved estimates of costs, aswell as the standard deviation of those costs
|-
| style="font-weight:bold;" | Limitations
| Not very precise estimations Mostly applicable in the beginning of a project
| Does not address for the ressources required for combining each activity
| Requires historical data which is both time consuming to gather and may not always be available
| Expensive & time consuming
| Time consuming to provide an estimate for three scenarios
|}

== Conclusion ==

The methodologies of cost estimation recommended by the PMBOK have been reviewed in this article. It is worth noting that the estimates' degree of information and complexity tends to rise as the project progresses. ROM estimates are typically the only kind of estimation available at the start phase. Bottom-up and parametric estimating methodologies, which are often only accessible later in a project's life cycle, are frequently required for definitive estimates, as these are the methods that generally produce the most precise cost estimates. They're typically employed when the budget has to be re-evaluated and a fresh estimate included at the end. Estimates that are more exact, such as parametric estimates based on historical statistical correlations of comparable projects, are not accessible in many projects. In such cases, the three-point estimation method is an effective way to analyse and balance subject matter expert estimates or top down estimation technique. The PERT distribution is undoubtedly the most precise method for condensing the worst-case, best-case, and most likely possibilities into a single value. The standard deviation is used to account for both the inherent errors and the possible dispersion of estimates. This might explain why, despite the fact that PERT has been available for decades and could have been used by our grandparents, it is still a popular tool for project estimating and scheduling.

== Annotated bibliography ==

'''H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100.''' This article provides the reader important information about how to estimate the budget accurately, when is the best time to calculate the budget and which cost estimation method is the optimal method for all types of project.

'''D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools.''' This E-book provides the overview of all cost estimation methods and tools to estimate the cost for all types of project. It has detailed description of estimated tools which can estimate cost of enterprise projects with maximum precision.

'''R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996.''' This article gives the reader an important information about expert judgment-based estimates of projects specifically in information technology and software domain

'''C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962.''' This article guides the reader how to use the PERT distribution, estimate the activity duration and cost accurately and how it is efficient method as compared to other estimation methods.

=References=

<references>

<ref name="budget">H. Kwon and C. W. Kang, “Improving Project Budget Estimation Accuracy and Precision by Analyzing Reserves for Both Identified and Unidentified Risks,” Project Management Journal, vol. 50, no. 1, pp. 86–100, Feb. 2019</ref>

<ref name="ref1"> Project Management: "Managing Successful Projects with PRINCE2" 6th Edition (2017) pp. 109–111 </ref>

<ref name="two">D. A. N. Gregory K. Mislick, Cost Estimation: Methods and Tools</ref>

<ref name="three"> Project Management: A guide to the Project Management Body of Knowledge (PMBOK guide). </ref>

<ref name="four">R. T. Hughes, “Expert judgement as an estimating method,” Information and Software Technology, vol. 38, no. 2, pp. 67–75, Jan. 1996</ref>

<ref name="five">C. E. Clark, “Letter to the Editor—The PERT Model for the Distribution of an Activity Time,” Operations Research, vol. 10, no. 3, pp. 405–406, Jun. 1962</ref>

<ref name="six"> Project Management - Three-Point Estimating and PERT Distribution (Cost & Time Estimation),” Available online: https://project-management.info/three-point-estimating-pert/</ref>

<ref name="seven"> Altexsoft - Rough Order of Magnitude: Making Initial Project Estimates with High Uncertainty,” Available online: https://www.altexsoft.com/blog/rough-order-of-magnitude/</ref>

<ref name="eight"> Researchgate - Triangular distribution vs. a PERT distribution,” Available online: https://www.researchgate.net/figure/Illustration-of-the-Triangular-distribution-vs-a-PERT-distribution-Vose-2006_fig6_224061457</ref>

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