Cost build up estimation in projects

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Abstract

Cost estimation is a critical aspect of the projects management that involves predicting the likely cost of the projects and determining its feasibility based on available resources and constraints. In this wiki article, an attempt will be made with a short mention, initially, about project cost management and cost estimation, continuing after with a holistic view of the factors that affect the costs of the projects and present the cost estimation techniques and practices that can be applied to get as close as possible to the actual cost of each project. There is a general view that the accuracy of cost estimates is crucial to all parties involved with the projects. As a result, it is very important to analyze the factors, the techniques and the practices that affect the estimation cost and how much these factors can help to build it up properly and efficiently. There are many factors and techniques, but a few of the most important ones are: about the factors-the complexity of the project, scale and scope of the project, time, if there is an accurate plan for the project, experience on the methods that required to be applied, the financial situation of the client & about the techniques- bottom-up estimating, parametric estimating, analogous estimating and of cource the mixed approaches. Moreover, in order to improve estimation accuracy, all the information about the factors must be collected and in conjunction with the estimation techniques, models and methodologies, the estimation process will become more accurate and easier. To conclude, cost estimation is a crucial component of project management that ensures that tasks are completed on time and within budget, alternatively companies may be severely harmed from the impact of incorrect cost estimates on their finances. Finally, the challenges and weaknesses will be identified in an attempt to make current cost estimation techniques and methods more effective. Project managers can make good decisions and complete their projects efficiently if they are well aware of the variables that affect cost, have a good understanding of cost estimating techniques and the importance of cost control and monitoring.

Introduction

Project cost overruns happen so regularly that, may, the operations research community should pay them greater attention, to provide further explanation of the issue of project budget overruns, to make recommendations for how to improve cost estimation as it provides a better chance for the projects to avoid hidden risks and cost blowouts. In this wiki article will strive to investigate how cost estimation can bult up in projects based on literature review in aiming to improve the performance of the project’s and to avoid wasted overruns. While many prior studies on cost estimation emphasized investigating cost estimation methods and techniques to improve the performance of cost estimation, less attention was given to the project factors that influence the cost estimating, the challenges, and the areas of implementation as well. Cost build up estimation one may say that is part of complexity perspective which, of course, is directly related to project cost management and regarding which we will make a small reference below in order to try to give a more complete and organized structure to our article. Finally, effective cost estimation is extremely important and hence project managers, it is important to have a clear understanding of the Project’s Cost, the factors that influencing cost estimations and select the appropriate methods and techniques so that the estimates are as accurate as possible. In the following sections, we will delve deeper into cost estimation and its significance in effective project cost management.[3],[4]

Project Cost Management Overview

Before we focus on our main topic, a brief mention must be done about project cost management. Thus project cost management includes the processes involved in planning, estimating, budgeting, financing, funding, managing, and controlling costs so that the project can be completed within the approved budget. The main processes of the Project Cost Management (PCM) are: Plan Cost Management − describing the process for estimating, budgeting, managing, monitoring, and controlling project costs, Estimate Costs − the process of estimating the financial resources required to finish a project, Determine Budget − a method of establishing an authorized cost baseline by combining the anticipated costs of various tasks or work packages and Control Costs − monitoring the project's progress in order to manage changes to the cost baseline and update project costs. The Project Cost Management processes are presented as discrete processes with defined interfaces, while in practice they overlap and interact in ways that cannot be completely detailed. Processes interact with each other and with processes in other Knowledge Areas.

The key concepts for project cost management, as referred to in the PMBOK GUIDE [4] are that: Project Cost Management is primarily concerned with the cost of the resources needed to complete project activities. Project Cost Management should consider the effect of project decisions on the subsequent recurring cost of using, maintaining, and supporting the product, service, or result of the project. For example, limiting the number of design reviews can reduce the cost of the project but could increase the resulting product’s operating costs. Another aspect of cost management is recognizing that different stakeholders measure project costs in different ways and at different times. For example, the cost of an acquired item may be measured when the acquisition decision is made or committed, the order is placed, the item is delivered, or the actual cost is incurred or recorded for project accounting purposes. In many organizations, predicting and analyzing the prospective financial performance of the project’s product is performed outside of the project. In others, such as a capital facilities project, Project Cost Management can include this work. When such predictions and analyses are included, Project Cost Management may address additional processes and numerous general financial management techniques such as return on investment, discounted cash flow, and investment payback analysis.[4]


Figure 1: Cost management through the project lifecycle

Cost Estimation Overview

Cost estimating involves developing an approximation (estimate) of the costs of the resources needed to complete project activities. It is a prediction that is based on the information known at a given point in time. Cost estimates include the dentification and consideration of costing alternatives to initiate and complete the project. Cost trade-offs and risks should be considered, such as make versus buy, buy versus lease, and the sharing of resources in order to achieve optimal costs for the project. The key benefit of this process is that it determines the monetary resources required for the project. This process is performed periodically throughout the project as needed. Ηere it should also be mentioned that depending on the complexity and the uniqueness of the project the cost estimation may not be so accurate. Factors like the unavailability of the historical information, the amount of technical expertise that required to understand the project is higher, the size and the uncertainty, can lead the responsible person who estimating the cost, to unreliable results and cost overruns. In this way, these situations are far more likely to occur in complex projects than in standard projects where typically only standard products and well-known suppliers are used, and thus makes it very difficult for the project controller to recognize such situations. Cost estimates are typically represented in units of some currency (e.g., dollars, euros, yen, etc.), but in some cases, other units of measure are used to assist comparisons by removing the impacts of currency fluctuations, such as staff hours or staff days. Cost estimates should be evaluated and adjusted during the project to take into account new information as it becomes available and hypotheses are tested. As a project moves through the project life cycle, its estimation accuracy will rise. A project at the start phase, for instance, might have a rough order of magnitude (ROM) estimate that falls between 25% and +75%. As the project progresses and more information becomes available, precise predictions may reduce the range of accuracy to 5% to 10%. There are rules for when such improvements can be made and the level of confidence or accuracy that is expected in specific businesses. Costs are estimated for all resources that will be charged to the project. This includes, but is not limited to, personnel, supplies, tools, services, and facilities, as well as unique categories such as inflation allowance, financing charges, or unforeseen expenses. Cost estimates can be displayed in summary or at the activity level. The inputs, tools and techniques, and outputs of this process are depicted in Figure1. Figure 2 depicts the data flow diagram of the process.[4][5][8] 


               Estimate costs 2.png
                      Figure 2. Estimate Costs: Inputs, Tools & Techniques, and Outputs
                                                      

               Estimate Costs, Data Flow Diagram 2.png
                      Figure 3. Estimate Costs: Data Flow Diagram


Factors influencing cost build up estimating

When creating the cost estimate, the estimating department takes a broad view of the project and considers several variables, including expected output levels during the construction stage. The estimating department determines the consolidated cost estimate by considering the resources needed for the project in terms of quantity, quality, cost, and performance, as well as other factors (such as the extent of information requirements, project environment, etc.) that may affect the performance of those resources. [1]

In a more general perspective factors that influencing cost build up estimating can be divided into four main categories:

  • Project-specific factors
  • Resource factors
  • Environmental factors
  • Economic factors

Since the construction industry has influenced most of the literature written on cost estimating projects as it has mainly complex projects, the following factors are the most crucial:

  • Complexity of design and construction
  • Method of construction techniques
  • Tender period and market condition
  • Site constraint - access and storage limitation
  • Clients’ financial situation and budget
  • Location of project
  • Availability and supplies of labor and materials
  • Project team’ s experience of the construction type
  • Lead times for delivery of materials
  • Form of procurement and contractual arrangement
  • Amount of special work / likely production time
  • Off/on-site operations sequencing and limitations
  • Expertise of consultants
  • Number of project team members [1]


It's important to consider all these factors when estimating project costs, to ensure that the estimate is accurate and reflects the actual cost of completing the project. Project managers must use their judgment and expertise to make informed decisions about these factors when estimating costs.

Cost estimation techniques

Product cost estimation techniques:

Qualitative techniques

  • Intuitive-estimates are based on the expert estimator’s experience.
  • Analogical-estimates made on the definition and the analysis of the degree of similarity between the new product and another one for which cost has been estimated in the past.

Quantitative techniques

  • Parametric-estimates based on an analytical function of a set of parameters characterising the product, without describing it completely. These are known to be top-down applications.
  • Analytical-based on a detailed analysis of the work required into the elementary tasks that constitute the manufacturing process. This is also termed as bottom up techniques where the cost data are collected from the smallest component levels and aggregated to the total product level.


Service cost estimation techniques:

• Expert opinion or judgment. Expertise should be considered from individuals or groups with specialized knowledge or training in the following topics:

• Previous similar projects.

• Information in the industry, discipline, and application area; and

• Cost estimating methods.

• Top-down costing. Top-down costing first calculates the total costs of the service at the organisational, provider or departmental level, then disaggregates the total costs to the department or the units of services (or products) depending on the richness of available data and the homogeneity of services provided. It can be done through multiple steps, e.g., allocate costs to cost centres (e.g., support services workshop, project management), then divide the total costs of the cost centre by the number of units (e.g., spares supplied, etc.) Top-down approach is less detailed and so accuracy can suffer. Furthermore, allocation of resources can be more or less arbitrary.

• Bottom-up estimating. Bottom-up estimating is a method of estimating a component of work. The cost of individual work packages or activities is estimated to the greatest level of specified detail. The detailed cost is then summarized or “rolled up” to higher levels for subsequent reporting and tracking purposes. The cost and accuracy of bottom-up cost estimating are typically influenced by the size or other attributes of the individual activity or work package.

• Parametric estimating. Parametric estimating uses a statistical relationship between relevant historical data and other variables (e.g., square footage in construction) to calculate a cost estimate for project work. This technique can produce higher levels of accuracy depending on the sophistication and underlying data built into the model. Parametric cost estimates can be applied to a total project or to segments of a project, in conjunction with other estimating methods.

• Analogous estimating. Analogous cost estimating uses values, or attributes, of a previous project that are similar to the current project. Values and attributes of the projects may include but are not limited to: scope, cost, budget, duration, and measures of scale (e.g., size, weight). Comparison of these project values, or attributes, becomes the basis for estimating the same parameter or measurement for the current project.

• Three point estimating. The accuracy of single-point cost estimates may be improved by considering estimation uncertainty and risk and using three estimates to define an approximate range for an activity’s cost:

• Most likely (cM). The cost of the activity, based on realistic effort assessment for the required work and any predicted expenses.

• Optimistic (cO). The cost based on analysis of the best-case scenario for the activity.

• Pessimistic (cP). The cost based on analysis of the worst-case scenario for the activity.

Depending on the assumed distribution of values within the range of the three estimates, the expected cost, cE, can be calculated using a formula. Two commonly used formulas are triangular and beta distributions. The formulas are:

• Triangular distribution. cE = (cO + cM + cP) / 3

• Beta distribution. cE = (cO + 4cM + cP) / 6

Cost estimates based on three points with an assumed distribution provide an expected cost and clarify the range of uncertainty around the expected cost.

• Data analysis.

Data analysis techniques that can be used in the Estimate Costs process include but are not limited to:

• Alternatives analysis. Alternatives analysis is a technique used to evaluate identified options in order to select which options or approaches to use to execute and perform the work of the project. An example would be evaluating the cost, schedule, resource, and quality impacts of buying versus making a deliverable.

• Reserve analysis. Cost estimates may include contingency reserves (sometimes called contingency allowances) to account for cost uncertainty. Contingency reserves are the budget within the cost baseline that is allocated for identified risks. Contingency reserves are often viewed as the part of the budget intended to address the known-unknowns that can affect a project. For example, rework for some project deliverables could be anticipated, while the amount of this rework is unknown. Contingency reserves may be estimated to account for this unknown amount of rework. Contingency reserves can be provided at any level from the specific activity to the entire project. The contingency reserve may be a percentage of the estimated cost, a fixed number, or may be developed by using quantitative analysis methods.

As more precise information about the project becomes available, the contingency reserve may be used, reduced, or eliminated. Contingency should be clearly identified in cost documentation. Contingency reserves are part of the cost baseline and the overall funding requirements for the project.

• Cost of quality. Assumptions about costs of quality (Section 8.1.2.3) may be used to prepare the estimates. This includes evaluating the cost impact of additional investment in conformance versus the cost of nonconformance. It can also include looking at short-term cost reductions versus the implication of more frequent problems later on in the product life cycle.

• Mixed approach

[2],[4]

Challenges in Cost Estimation Management and Areas for Improvement

There are many things that could be done better to make estimation more effective in cost management, but there are many challenges and weaknesses that need to be addressed to make current cost estimation techniques and methods more effective. Also, the understanding of the relationship between customer satisfaction and costs is critical to tracing the origins of customer-level profitability as the need for businesses to become more customer-centric increases. The aforementioned factors and techniques are mainly related to management tools, and little attention has been paid to human communication, either that means communication with the customer or communication of the associated members. Cost modeling still has room for improvement in terms of accuracy and joint cost modeling. In the challenges that will be mentioned below, the complexity, the amount of information, uncertainty, predetermination, human factors, and the other factors play an important role.


Olav Torp and Ole Jonny Klakegg in their article referring to their article Johansen et al. [7] and using as a case study of the Decommissioning of Barsebäck Nuclear Power Plant, addresses in their discussion the following challenges. Those challenges related to project cost estimation and the measures to solve present issues by enhancing the cost estimation and uncertainty analysis process especially for complicated projects in order managers may be able to estimate the appropriate level of expected costs for each project. The following is a list and explanation of those five challenges:


  • The resource group is not well composed
  • Too much details in the cost estimation models
  • There is no focus on opportunities
  • The level of uncertainty is underestimated in all phases and
  • The expected cost is underestimated


The challenge of composing the group with the ideal combination of subject matter expertise and skill sets, to guarantee a diverse variety of viewpoints is very important. Instead of taking into account the appropriate mix of abilities and backgrounds, groups are frequently established based on the availability of specific persons. Despite the fact that their attention may be more narrowly focused on technical rather than more general issues, technical experts frequently receive priority. It is also significant to consider how project participants' desired attitudes about risk are impacted by situational factors including training, role, and accountability. The team gained a fundamental knowledge of the technique to be used, and the roles of various persons within the project were better understood by holding planning meetings and discussing the project's approach with the group members. Even while there may still be disparities in the group's attitudes about risk, these variations can be useful if they are successfully tapped. Another challenge is the level of detail in cost estimation procedures and how it affects the project overview and uncertainty. The acceptable and practical amount of detail in considering the time and data at availability is questioned. Due to thorough planning and data modeling, the Barsebäck analysis' three-day workshop allowed for a thorough evaluation of cost items, uncertainty factors, and analysis findings. To talk about specific incidents and risk-reduction measures, though, would have taken too much time. The benefits of stepwise decomposition and reassessment of the cost items with the highest degree of uncertainty could not be fully reaped by the workshop. Although the cost breakdown structure is followed, there is less estimated uncertainty as the depth of information increases. The treatment of association between components, however, increases complexity. The challenge of identifying opportunities highlights the importance of openly addressing them while identifying uncertainty. If opportunities aren't asked to be found sufficiently, risks end up taking center stage. Despite the fact that risks and opportunities are two sides of the same coin, it is crucial to distinguish between them while discussing them to maintain a clear focus on both. As part of the brainstorming process for decommissioning Barsebäck, the group explicitly identified and investigated opportunities. Finding a solution for safe interim storage was one significant opportunity that was found. This could allow for earlier decommissioning, add value for the community, reduce costs by about 15%, and shorten the overall project duration, reducing contextual uncertainties. The group thought about two different future possibilities as a result of this opportunity. Although further planning is required to evaluate their viability, the group was able to discover major potential by correctly addressing opportunities. The calculated level of uncertainty in uncertainty studies shows that the standard deviation frequently appears to be erroneously low in such analyses. The complexity, maturity, and length of time from the analysis to project completion are some of the variables that affect the level of uncertainty. The computed standard deviation for the Barsebäck project, which is in the planning and feasibility study stages, was higher than 20%. The level of uncertainty in Barsebäck was significantly higher when compared to a study of 100 Norwegian infrastructure projects, which produced a standard deviation between 6% and 12%. The right amount of ambiguity, though, is still up in the air. According to the article, consistently addressing uncertainties, communicating all uncertainty-related effects through input, and providing correlations between connected items all helped to achieve higher degrees of uncertainty. Additionally, the essay suggests selecting extreme estimates from various group members to use as input for triple estimations. When it comes to underestimated cost levels, the majority of projects have cost escalations, with an average increase of 28%. Even if the cost estimation procedure and uncertainty analysis are of the highest caliber, we cannot predict if the Barsebäck example project will experience a cost escalation.[6]


Moreover, Jaakko Kujala et al. [8] at their article refer that over the years, numerous methodologies, standards, strategies, and tools have been developed to aid in the effective cost estimation of projects. However, large initiatives across a variety of industries, including IT, defense, financial services, and construction, continue to struggle with poor effectiveness and failure to produce the desired results. A better understanding of project complexity could help to better understand the relationship between practices and outcomes in project-based processes and that it is important to draw differences between various types of projects.

In their final discussion they quote that among the most crucial cost management tasks and subtasks related to the execution phase of complex projects are updating the project cost estimates, monitoring project costs, controlling project costs, calculating and releasing particular contingencies, calculating margins, and profitability analysis. The main challenges related to estimation cost in management in complex projects, which were characterized by the following attributes: large size, complexity, uncertainty and uniqueness. Conducting estimation costs in complex projects effectively creates new challenges in terms of the organizational structure, project management, and employee competency. In cost management, function faces unique challenges as projects become more complicated because many of the old cost estimation techniques are unable to handle the complex and unpredictable nature of today's large-scale projects. Additionally, estimating cost in complex projects offer individualized solutions to address the customer's problem, hence the final solution frequently diverges dramatically from those of earlier projects. The estimations are inaccurate because of a lack of experience with comparable projects and the limited accessibility of the previous data. Furthermore, the collaboration of numerous internal and external stakeholders is an important challenge for cost control in large projects. Managing and estimating supplier expenses becomes more challenging as the number of suppliers rises. Also, the uniqueness of a project always causes cost overruns and of course it is a great challenge. Finally, is quite challenging for cost calculation and the financial statements to provide the proper information for the reliable calculation of the project’s cost, and the percentage of completion of the project to be reliably quantified in the financial statement.[8]

Conclusion

In conclusion, cost estimation is an important component of project management that ensures projects are finished on schedule and within budget. Since inaccurate cost estimates can have serious financial consequences for businesses, accurate cost estimating is crucial for all stakeholders engaged in a project. It is crucial to consider a variety of elements that affect cost build-up, such as the complexity of the project, scale and scope, time, proper project planning, familiarity with essential procedures, and the client's financial status, in order to increase the accuracy of cost estimating. In addition, the cost estimation techniques and practices that can be used can greatly contribute to improving the accuracy of the cost estimate or how it can be build-up, including bottom-up estimating, parametric estimating, analogous estimating, and mixed approaches. Based on the information available, these methodologies use both qualitative and quantitative methods to create estimates of project costs. To increase accuracy, it is crucial to compile all pertinent data regarding the variables affecting cost estimation and to use the appropriate approaches, models, and methodologies. Nevertheless, there are challenges and there is plenty of opportunity for improvement in cost estimation management. These include addressing weaknesses in current techniques and methods, improving the accuracy of cost modeling, and considering human communication when estimating projects. Furthermore, achieving customer-centric profitability depends on a knowledge of the link between expenses and customer pleasure. Overall, accurate cost estimating is essential for project managers to make informed decisions, complete projects efficiently, and prevent cost overruns. Project managers can improve the accuracy of cost estimates and ensure successful project cost management by considering all factors affecting cost build-up and using the right estimating strategies.

Annotated Bibliography

Partha P. Datta a, Rajkumar Roy, Available online: August 2010, Cost modelling techniques for availability type service support contracts:A literature review and empirical study.

The research in this paper is focused on enhancing existing knowledge in cost estimation models for availability type support service contracts that focus on equipment availability targets and predefined service levels.The difficulty of this task lies in properly estimating the costs of activities during the long lasting contracts, which in some cases may reach even several decades.

Project Management Institute, 2017, A Guide to the PROJECT MANAGEMENT BODY OF KNOWLEDGE, (PMBOK® GUIDE) Sixth Edition.

The PMBOK® Guide provides more detail about key concepts, emerging trends, considerations for tailoring the project management processes, and information on how tools and techniques are applied to projects. Project managers may use one or more methodologies to implement the project management processes outlined in the standard.

Olav Torp and Ole Jonny Klakegg, October 2016, Challenges in Cost Estimation under Uncertainty-A Case Study of the Decommissioning of Barsebäck Nuclear Power Plant, Department of Civil and Transport Engineering, Norwegian University of Science and Technology, Trondheim 7491, Norway.

This paper look into some challenges with the practice in cost estimation processes and identify possible improvements to overcome them. The purpose of this paper is to illustrate better solutions to some of the major weaknesses identified in current cost estimation practice.

Jaakko Kujala, Tim Brady & Jaakko Putila, October 2014, Challenges of Cost Management in Complex Projects. International Journal of Business and Management, Vol. 9, No. 11.

This paper, is build on existing research on complex products and systems (CoPS) to address the challenges of managing costs in projects of varying complexity. Based on a qualitative case study, several challenges identified in performing various cost management functions related to cost estimation, cost control and monitoring, revenue recognition, profitability analysis and margin calculation.

References

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