Project Cost Management

Chapter 7:
Project Cost Management
Information Technology Project

Management, Eighth Edition
Note: See the text itself for full citations.

Learning Objectives
 Understand the importance of project cost
management
 Explain basic project cost management principles,
concepts, and terms

 Describe the process of planning cost
management
 Discuss different types of cost estimates and
methods for preparing them

Management, Eighth Edition Copyright 2016 2
Learning Objectives
 Understand the processes of determining a
budget and preparing a cost estimate for an
information technology (IT) project
 Understand the benefits of earned value
management and project portfolio management to

assist in cost control
 Describe how project management software can
assist in project cost management

The Importance of Project Cost
Management
 IT projects have a poor track record for meeting
budget goals
 A cost overrun is the additional percentage or dollar
amount by which actual costs exceed estimates

 A 2011 Harvard Business Review study reported an
average cost overrun of 27 percent. The most

important finding was the discovery of a large
number of gigantic overages or “black swans”

What Went Wrong?
 The United Kingdom’s National Health Service IT
modernization program was called the greatest IT disaster in
history with an estimated $26 billion overrun
 The program had problems due to incompatible systems,
resistance from physicians, and arguments among
contractors about who’s responsible for what
 It was finally scrapped in 2011

What is Cost and Project Cost
Management?
 Cost is a resource sacrificed or foregone to achieve
a specific objective or something given up in
exchange
 Costs are usually measured in monetary units like
dollars
 Project cost management includes the processes
required to ensure that the project is completed

within an approved budget

Project Cost Management Processes
 Planning cost management :determining the
policies, procedures, and documentation that will
be used for planning, executing, and controlling
project cost.
 Estimating costs: developing an approximation or
estimate of the costs of the resources needed to

complete a project
 Determining the budget: allocating the overall
cost estimate to individual work items to establish a

baseline for measuring performance
 Controlling costs: controlling changes to the
project budget
Figure 7-1. Project Cost Management
Summary

Basic Principles of Cost Management
 Most members of an executive board better
understand and are more interested in financial
terms than IT terms , so IT project managers must
speak their language
◦ Profits are revenues minus expenditures
◦ Profit margin is the ratio of revenues to profits
◦ Life cycle costing considers the total cost of ownership,
or development plus support costs, for a project
◦ Cash flow analysis determines the estimated annual
costs and benefits for a project and the resulting annual
cash flow

Media Snapshot
 You cannot measure ROI unless you have a
benefits measurement process in place
 A 2015 report by PMI found:
◦ Only 20 percent of organizations report having a high

level of benefits realization maturity
◦ 39 percent of high-performing organizations report high
benefits realization maturity compared to 9 percent of low
performers

What Went Right?
 Investing in green IT and other initiatives has helped both
the environment and companies’ bottom lines
 Michael Dell, CEO of Dell, reached his goal to make his
company “carbon neutral” in 2008
 As of March 2012, Dell had helped its customers save
almost $7 billion in energy costs
 In 2014 Dell reported being on track toward reaching their
goal of recovering 2 billion pounds of used electronics by
2020

Types of Costs and Benefits
 Tangible costs or benefits are those costs or
benefits that an organization can easily measure in
dollars
 Intangible costs or benefits are costs or benefits
that are difficult to measure in monetary terms
 Direct costs are costs that can be directly related
to producing the products and services of the
project
 Indirect costs are costs that are not directly
related to the products or services of the project,
but are indirectly related to performing the project
 Sunk cost is money that has been spent in the
past; when deciding what projects to invest in or
continue, you should not include sunk costs

More Basic Principles of Cost Management
 Learning curve theory states that when many

items are produced repetitively, the unit cost of
those items decreases in a regular pattern as
more units are produced
 Reserves are dollars included in a cost estimate
to mitigate cost risk by allowing for future
situations that are difficult to predict
◦ Contingency reserves allow for future situations that
may be partially planned for (sometimes called known
unknowns) and are included in the project cost baseline
◦ Management reserves allow for future situations that
are unpredictable (sometimes called unknown
unknowns

Planning Cost Management
 The project team uses expert judgment, analytical
techniques, and meetings to develop the cost
management plan
 A cost management plan includes:
◦ Level of accuracy and units of measure

◦ Organizational procedure links
◦ Control thresholds
◦ Rules of performance measurement
◦ Reporting formats
◦ Process descriptions

Estimating Costs
 Project managers must take cost estimates
seriously if they want to complete projects within
budget constraints
 It’s important to know the types of cost estimates,
how to prepare cost estimates, and typical

problems associated with IT cost estimates

Table 7-1. Types of Cost Estimates

More on Cost Estimates
 The number and type of cost estimates vary by
application area. The Association for the
Advancement of Cost Engineering International
identifies five types of cost estimates for
construction projects: order of magnitude,
conceptual, preliminary, definitive, and control
 Estimates are usually done at various stages of a
project and should become more accurate as time

progresses
 A large percentage of total project costs are often
labor costs

Table 7-2. Maximum FTE by
Department by Year

Cost Estimation Tools and Techniques
 Basic tools and techniques for cost estimates:
◦ Analogous or top-down estimates: use the actual cost
of a previous, similar project as the basis for estimating
the cost of the current project
◦ Bottom-up estimates: involve estimating individual work
items or activities and summing them to get a project total
◦ Parametric modeling uses project characteristics
(parameters) in a mathematical model to estimate project
costs

Typical Problems with IT Cost
Estimates
 Estimates are done too quickly
 People lack estimating experience
 Human beings are biased toward underestimation
 Management desires accuracy

Sample Cost Estimate
 See the text for a detailed example of creating a
cost estimate for the Surveyor Pro project
described in the opening case
 Before creating an estimate, know what it will be
used for, gather as much information as possible,

and clarify the ground rules and assumptions for
the estimate
 If possible, estimate costs by major WBS
categories
 Create a cost model to make it easy to make
changes to and document the estimate

Figure 7-2. Surveyor Pro Project Cost Estimate

Figure 7-3. Surveyor Pro Software
Development Estimate

Best Practice
 Alvin Alexander wrote a book called Cost
Estimating in an Agile Development Environment
in 2015
 Function points are a means of measuring
software size in terms that are meaningful to end

users
 User stories are a common way to describe
requirements in a simple, concise way

 Developers can analyze user stories to estimate
function points and person-hours

Determining the Budget
 Cost budgeting involves allocating the project cost
estimate to individual work items over time
 The WBS is a required input to the cost budgeting
process since it defines the work items

 Important goal is to produce a cost baseline
◦ a time-phased budget that project managers use to

measure and monitor cost performance

Figure 7-4. Surveyor Pro Project Cost
Baseline

Controlling Costs
 Project cost control includes
◦ Monitoring cost performance
◦ Ensuring that only appropriate project changes are
included in a revised cost baseline
◦ Informing project stakeholders of authorized changes to
the project that will affect costs
 Many organizations around the globe have
problems with cost control

Earned Value Management (EVM)
 EVM is a project performance measurement
technique that integrates scope, time, and cost data
 Given a baseline (original plan plus approved
changes), you can determine how well the project is

meeting its goals
 You must enter actual information periodically to
use EVM
 More and more organizations around the world are
using EVM to help control project costs

Earned Value Management Terms
 The planned value (PV), formerly called the budgeted
cost of work scheduled (BCWS), also called the budget,
is that portion of the approved total cost estimate planned
to be spent on an activity during a given period
 Actual cost (AC), formerly called actual cost of work
performed (ACWP), is the total of direct and indirect
costs incurred in accomplishing work on an activity during
a given period
 The earned value (EV), formerly called the budgeted
cost of work performed (BCWP), is an estimate of the
value of the physical work actually completed
 EV is based on the original planned costs for the project
or activity and the rate at which the team is completing
work on the project or activity to date

Rate of Performance
 Rate of performance (RP) is the ratio of actual
work completed to the percentage of work planned
to have been completed at any given time during
the life of the project or activity
 Brenda Taylor, Senior Project Manager in South
Africa, suggests this term and approach for
estimating earned value
 For example, suppose the server installation was
halfway completed by the end of week 1. The rate
of performance would be 50% because by the end
of week 1, the planned schedule reflects that the
task should be 100 percent complete and only 50
percent of that work has been completed
Table 7-3. Earned Value Calculations
for One Activity After Week One

Table 7-4. Earned Value Formulas

Rules of Thumb for Earned Value
Numbers
 Negative numbers for cost and schedule variance
indicate problems in those areas
 CPI and SPI less than 100% indicate problems
 Problems mean the project is costing more than
planned (over budget) or taking longer than

planned (behind schedule)
 The CPI can be used to calculate the estimate at
completion (EAC)—an estimate of what it will

cost to complete the project based on
performance to date. The budget at completion
(BAC) is the original total budget for the project
Figure 7-5. Earned Value Chart for
Project after Five Months

Global Issues
 EVM is used worldwide, and it is particularly
popular in the Middle East, South Asia, Canada,
and Europe
 Most countries require EVM for large defense or
government projects, as shown in Figure 7-6

 EVM is also used in such private-industry sectors
as IT, construction, energy, and manufacturing.

 However, most private companies have not yet
applied EVM to their projects because management

does not require it, feeling it is too complex and not
cost effective
Figure 7-6. Earned Value Usage

Project Portfolio Management
 Many organizations collect and control an entire
suite of projects or investments as one set of
interrelated activities in a portfolio
 Five levels for project portfolio management
1. Put all your projects in one database
2. Prioritize the projects in your database
3. Divide your projects into two or three budgets based on
type of investment
4. Automate the repository
5. Apply modern portfolio theory, including risk-return tools
that map project risk on a curve

Benefits of Portfolio Management
 Schlumberger saved $3 million in one year by
organizing 120 information technology projects into a
portfolio
 Reduced redundant projects and coordinated those
with overlap
 IT projects can be huge investments, so it makes
sense to view them as portfolios and track their
progress as a whole

Using Software to Assist in Cost
Management
 Spreadsheets are a common tool for resource
planning, cost estimating, cost budgeting, and
cost control
 Many companies use more sophisticated and
centralized financial applications software for cost
information
 Project management software has many cost-
related features, especially enterprise PM
software
 Portfolio management software can help reduce
costs

Recent Studies on PPM Software
 2014 Gartner report says the market continues to
grow, with annual sales over $1.65 billion in 2014
report. The pace of change is driving the demand
for enterprise software to help manage projects
 Forrester estimates ROIs of 250 percent from
PPM tools
 Pfizer and Ford use PPM software to improve
transparency of the many projects they manage

Chapter Summary
 Project cost management is a traditionally weak
area of IT projects, and project managers must
work to improve their ability to deliver projects
within approved budgets
 Main processes include
◦ Plan cost management

◦ Estimate costs
◦ Determine the budget
◦ Control costs


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Chapter 7:

Project Cost Management

Information Technology Project

Note: See the text itself for full citations.

concepts, and terms

methods for preparing them

Information Technology Project

management and project portfolio management to

assist in project cost management

Information Technology Project

amount by which actual costs exceed estimates

average cost overrun of 27 percent. The most

Information Technology Project

Information Technology Project

required to ensure that the project is completed

Information Technology Project

estimate of the costs of the resources needed to

cost estimate to individual work items to establish a

Information Technology Project

Information Technology Project

◦ Only 20 percent of organizations report having a high

Information Technology Project

Information Technology Project

Information Technology Project

 Learning curve theory states that when many

Information Technology Project

◦ Level of accuracy and units of measure

Information Technology Project

how to prepare cost estimates, and typical

Information Technology Project

Information Technology Project

project and should become more accurate as time

Information Technology Project

Information Technology Project

Information Technology Project

Information Technology Project

used for, gather as much information as possible,

changes to and document the estimate

Information Technology Project

Information Technology Project

Information Technology Project

software size in terms that are meaningful to end

requirements in a simple, concise way

function points and person-hours

Information Technology Project

process since it defines the work items

◦ a time-phased budget that project managers use to

Information Technology Project

Information Technology Project

Information Technology Project

changes), you can determine how well the project is

using EVM to help control project costs

Information Technology Project

Information Technology Project

Information Technology Project

Information Technology Project

planned (over budget) or taking longer than

completion (EAC)—an estimate of what it will

Information Technology Project