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Chapter 7:Project Cost Management

Information Technology

Project Management,

Fifth Edition

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Learning Objectives

Understand the importance of project costmanagement

Explain basic project cost managementprinciples, concepts, and terms

Discuss different types of cost estimates andmethods for preparing them

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Learning Objectives (continued)

Understand the processes involved in costbudgeting and preparing a cost estimate, andbudget for an information technology project

Understand the benefits of earned valuemanagement and project portfolio managementto assist in cost control

Describe how project management software can

assist in project cost management


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The Importance of Project Cost

Management IT projects have a poor track record for meeting

budget goals

The CHAOS studies found the average costoverrun (the additional percentage or dollaramount by which actual costs exceed estimates)ranged from 180 percent in 1994 to 43 percent in

2002; other studies found overruns to be 33-34percent


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What Went Wrong?

The U.S. Internal Revenue Service (IRS) continues toprovide examples of how not to manage costs A series of project failures in the 1990s cost taxpayers more than

$50 billion a year

In 2004, CIO Magazine reported problems with the IRSs $8 billionmodernization project

In 2006, the IRS was in the news for a botched upgrade to itsfraud-detection software, costing $318 million in fraudulent refundsthat didnt get caught

The United Kingdoms National Health Service ITmodernization program was called the greatest IT disasterin history by a London columnist, with an estimated $26billion overrun

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What is Cost and Project CostManagement?

Cost is a resource sacrificed or foregone toachieve a specific objective or something given upin exchange

Costs are usually measured in monetary units likedollars

Project cost management includes the

processes required to ensure that the project iscompleted within an approved budget


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Project Cost Management Processes

Cost estimating: developing an approximation orestimate of the costs of the resources needed tocomplete a project

Cost budgeting: allocating the overall cost

estimate to individual work items to establish abaseline for measuring performance

Cost control: controlling changes to the projectbudget


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Figure 7-1: Project Cost

Management Summary


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Basic Principles of CostManagement Most members of an executive board better

understand and are more interested in financialterms 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 annualcash flow


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Table 7-1: Cost of Software Defects


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What Went Right?

A leading telecommunications company estimated thecost of a software bug or defect at three stages: aftercoding, after manual inspection, and after beta release

The costs to correct the defect increased with each stage

from $2,000 to $10,000 to $100,000 The company estimated that when it released one million

lines of new code, it had an average of 440 defects in theearly stage, 250 in the middle stage, and 125 in the late

stage, costing more than $15 million They decided to implement an automated inspection

process, which reduced costs for fixing bugs by more than$11 million


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Basic Principles of Cost

Management Tangible costs orbenefits are those costs orbenefits that an organization can easily measure indollars

Intangible costs orbenefits 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 areindirectly 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 notinclude sunk costs


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Learning curve theory states that when manyitems are produced repetitively, the unit cost ofthose items decreases in a regular pattern asmore units are produced

Reserves are dollars included in a cost estimateto mitigate cost risk by allowing for futuresituations that are difficult to predict Contingency reserves allow for future situations that

may be partially planned for (sometimes called knownunknowns) and are included in the project costbaseline

Management reserves allow for future situations thatare unpredictable (sometimes called unknownunknowns)


Basic Principles of CostManagement (continued)

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Cost Estimating

Project managers must take cost estimatesseriously if they want to complete projects withinbudget constraints

Its important to know the types of cost estimates,how to prepare cost estimates, and typicalproblems associated with IT cost estimates


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Table 7-2: Types of Cost Estimates


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Cost Management Plan

A cost management plan is a document thatdescribes how the organization will manage costvariance on the project

A large percentage of total project costs are oftenlabor costs, so project managers must developand track estimates for labor


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Table 7-3: Maximum Departmental

Headcounts by Year


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Cost Estimation Tools and Techniques

Basic tools and techniques for cost estimates Analogous ortop-down estimates:use the actual

cost of a previous, similar project as the basis forestimating the cost of the current project

Bottom-up estimates: involve estimating individualwork items or activities and summing them to get aproject total

Parametric modeling:uses project characteristics

(parameters) in a mathematical model to estimateproject costs


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Typical Problems with IT Cost

Estimates Estimates are done too quickly

Lack of estimating experience

Human beings are biased toward underestimation Management desires accuracy


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Sample Cost Estimate

See pp. 277-281 for a detailed example ofcreating a cost estimate for the Surveyor Proproject 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 forthe estimate

If possible, estimate costs by major WBScategories

Create a cost model to make it easy to makechanges to and document the estimate


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Figure 7-2: Surveyor Pro Project CostEstimate


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Figure 7-3: Surveyor Pro SoftwareDevelopment Estimate


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Cost Budgeting

Cost budgeting involves allocating the project costestimate to individual work items over time

The WBS is a required input to the cost budgetingprocess since it defines the work items

An important goal is to produce a cost baselineA time-phased budget that project managers use to

measure and monitor cost performance


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Figure 7-4: Surveyor Pro Project

Cost Baseline

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

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Cost Control

Project cost control includes: Monitoring cost performance

Ensuring that only appropriate project changes areincluded in a revised cost baseline

Informing project stakeholders of authorized changesto the project that will affect costs

Many organizations around the globe haveproblems with cost control


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Media Snapshot

Australia: problems with the installation of an ERP system atCrane Group Ltd. led to an estimated cost overrun of $11.5million

India: as many as 274 projects currently under implementationin the Central sector are suffering serious cost and time

overruns Pakistan: Pakistan has sustained a cost overrun of Rs 1.798

billion (over $30 million U.S. dollars) in the execution of the66.5 megawatt Jagran Hydropower Project in the NeelumValley

United States: Northern California lawmakers were outragedover Governor Arnold Schwarzenegger's announcement thatcommuters should have to pay construction costs on Bay AreabridgesMaybe it takes the Terminator to help control costs!


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Earned Value Management (EVM)

EVM is a project performance measurementtechnique that integrates scope, time, and costdata

Given a baseline (original plan plus approved

changes), you can determine how well the projectis 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


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Earned Value Management Terms

The planned value (PV), formerly called the budgetedcost of work scheduled (BCWS), also called the budget, isthat portion of the approved total cost estimate planned tobe 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 costsincurred in accomplishing work on an activity during agiven period

The earned value (EV), formerly called the budgeted costof work performed (BCWP), is an estimate of the value ofthe physical work actually completed

EV is based on the original planned costs for the projector activity and the rate at which the team is completingwork on the project or activity to date


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Rate of Performance Rate of performance (RP) is the ratio of actual

work completed to the percentage of work plannedto have been completed at any given time duringthe life of the project or activity

Brenda Taylor, Senior Project Manager in SouthAfrica, suggests this term and approach forestimating earned value

For example, suppose the server installation washalfway completed by the end of week 1; the rateof performance would be 50% because by the endof week 1, the planned schedule reflects that thetask should be 100% complete and only 50% ofthat work has been completed


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Table 7-4 Earned Value Calculationsfor One Activity After Week One


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Table 7-5: Earned Value Formulas


R l f Th b f E d V l

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Rules of Thumb for Earned ValueNumbers 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 thanplanned (over budget) or taking longer thanplanned (behind schedule)

The CPI can be used to calculate the estimate at

completion (EAC)an estimate of what it willcost to complete the project based onperformance to date; the budget at completion(BAC) is the original total budget for the project


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Figure 7-5: Earned Value Chart forProject after Five Months


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Project Portfolio Management

Many organizations collect and control an entire

suite of projects or investments as one set ofinterrelated activities in a portfolio

Five levels for project portfolio management1. Put all your projects in one database2. Prioritize the projects in your database3. Divide your projects into two or three budgets based on

type of investment4. Automate the repository

5. Apply modern portfolio theory, including risk-returntools that map project risk on a curve


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Benefits of Portfolio Management Schlumberger saved $3 million in one year by

organizing 120 information technology projectsinto a portfolio

META Group research shows that: Organizations that evaluate information technology

projects by what their business impacts are and whattheir potential business values will be implement projectsthat result in 25 percent more improvement to the bottomline

Business executives state that using project portfoliomanagement allows managers to make decisions fasterand with more confidence


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Best Practice A global survey released by Borland Software in 2006

suggests that many organizations are still at a low level ofmaturity in terms of how they define project goals, allocateresources, and measure overall success of theirinformation technology portfolios

Some of the findings include the following: Only 22 percent of survey respondents reported that their

organization either effectively or very effectively uses a project planfor managing projects

Only 17 percent have either rigorous or very rigorous processes for

project plans, which include developing a baseline and estimatingschedule, cost, and business impact of projects

Only 20 percent agreed their organizations monitor portfolioprogress and coordinate across interdependent projects


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Using Software to Assist in CostManagement

Spreadsheets are a common tool for resourceplanning, cost estimating, cost budgeting, andcost control

Many companies use more sophisticated andcentralized financial applications software for costinformation

Project management software has many cost-

related features, especially enterprise PMsoftware


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Chapter Summary

Project cost management is a traditionally weakarea of IT projects, and project managers mustwork to improve their ability to deliver projectswithin approved budgets

Main processes include: Cost estimating

Cost budgeting

Cost control

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