COST ESTIMATING MODELS

Estimation

In statistics, estimation refers to a process in which one makes influences about a population. An
estimation of population parameters may be estimated in two ways:

(i) if the estimate consists single value or point then it is called point estimate
(ii) (ii) if the estimate give a range of value then it is called interval estimate.

Estimation (or estimating) is the process of finding an estimate, or approximation, which is a value that is
usable for some purpose even if input data may be incomplete, uncertain, or unstable. The value is
nonetheless usable because it is derived from the best information available. Typically, estimation
involves "using the value of a statistic derived from a sample to estimate the value of a corresponding
population parameter". The sample provides information that can be projected, through various formal
or informal processes, to determine a range most likely to describe the missing information. An estimate
that turns out to be incorrect will be an overestimate if the estimate exceeded the actual result, and
an underestimate if the estimate fell short of the actual result.

Difficulties in cost estimation

Estimating is difficult because the future is unknown. With few exceptions (such as with legal contracts)
it is difficult to anticipate future economic consequences exactly. In this section we discuss several
aspects of estimating that make it a difficult task. Engineering economic analysis includes present and
future economic factors; thus, it is critical to obtain reliable estimates of future costs, benefits and other
economic parameters. Difficulties in developing cost estimates arise from such conditions as one-of-a-
kind estimates, resource availability, and estimator expertise. Generally the quality of a cost estimate
increases as the resources allocated to developing the estimate increase. The benefits expected from
improving a cost estimate should outweigh the cost of devoting additional resources to the estimate
improvement.

Cost Estimate Models :

Per-unit Model

Here in this model a cost estimate is made for a single unit, then the total cost estimate results from
multiplying the estimated cost per unit times the number of units. This model is applicable for those
types of product where various cost components like raw materials, labour and other overheads cost
are identifiable and determined for a single unit of production.

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Segmenting Model

Here partitions the total estimation task into segments. Each segment is estimated, and then the
segment estimates are combined for the total cost estimate. Like if cost for any student fest to be
calculated first it is segmented into the category of decoration, artiste cost, entertainment and food,
travelling, advertisement etc. cost of each segment is calculated and then added to derive the total cost.

Power-Sizing model

This is a practically an effect of economy of scale. Any cost of producing / manufacturing any product
will not be increased in same proportion as the units are increased. For example, the cost of producing
10 units will typically be less than ten times of the comparable production cost of a single product. Cost
of economic comparable production cost depends on an exponential factor termed as Power Sizing
Exponent

To estimate the cost of B based on the cost of comparable item A, use the equation

Cost of B = (Cost of A) [("Size" of B) / ("Size" of A)]X

Here X is the appropriate power-sizing exponent, available from a variety of sources of/ past
performance of production.

Learning Curve Model

Here cost estimating is based on the assumption that as a particular task is repeated and the operator
systematically becomes quicker at performing the task. In particular, the model is based on the
assumption that the time required to complete the task for production unit 2x is a fixed percentage and
will be less than the double of the time required for production unit x for all positive, integer x. e.g., if 5
hrs is required for producing a single unit and the learning rate is 80 % then to producing 2 units will be
5×2×80% = 8 hrs. and producing double the units i.e., 4 units will be 8 Hrs. × 2 × 80 % = 12.8 hrs.

Benefits of Learning Curve

Learning curve is applicable to the industries with high labour turnover. As labour hours reduces
resulting to reduction of labour cost and this learning curve model would help in preparing the labour
requirement and cost budget. It also helps in reducing the idle time by proper works scheduling
considering the learning effect. There are huge advantages of this improvement and learning curve.

a. Provides cost reduction opportunities.

b. Evaluate effectiveness of training programmes.

c. Helps in proper work scheduling.

d. It is important tool in making working capital budget.

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 e. Helps in proper staff recruitment programmes.

Limitations of Learning Curve

Cost of Entry: Every activity in which a human can engage has a cost of entry. For example, if a
person chooses to play a new video game, the cost of entry is purchasing the game plus
whatever time it takes to master the controls. Activities with steep learning curves have a high
cost of entry since participants must spend more of their time learning the basics before they
can truly enjoy themselves. A high cost of entry may turn off potential customers or participants
who decide that your product’s steep learning curve simply is not worth their time.
Frustration: Any time you learn something new, there is a chance for frustration to build. New
tasks are unfamiliar and require careful attention, and in activities with steep learning curves,
mistakes can be quite costly. If you were trying to teach a person to sculpt marble, for example,
every mistake could cost that person hundreds of dollars in supplies. When the amount of
frustration experienced by a person learning a task outweighs his potential enjoyment of that
task, he is more likely to quit than continue. A steep learning curve may force new customers to
walk away from a product or service before truly experiencing its benefits.
Exclusion: One of the benefits of offering an activity with a steep learning curve is the
participants that hang around are truly dedicated to the task. By weeding out people with casual
interests or low frustration barriers, you ensure that your customers are all of a certain mindset
and caliber. A steep learning curve is an easy way to keep people who may not stick with a given
activity or product from wasting too much of your time, as it pushes them out much earlier than
they would naturally lose interest.
Satisfaction: When a service or product has a steep learning curve, the people who do stick
around to master it feel an immense sense of accomplishment they would not get if the product
were simple to use. Following the example of video games again, in games with high difficulty
levels and brutal learning curves, the gamer who sticks it out to the end is going to feel a greater
sense of satisfaction from completing the game than she would if the game were easy from start
to finish. Steep learning curves may keep some people away, but they can also keep some
people coming back for more.

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