Chapter 5:

Project Cost Management

Information Technology Project Management, Ninth Edition
Learning Objectives (1 of 2)

• Develop a justification for project cost management and its

importance in achieving project success
• 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
• Using an example of an information technology (IT) project, list and
describe the processes of determining a budget and preparing a cost
estimate
Learning Objectives (2 of 2)

• Justify the use of earned value management and project portfolio

management to assist in cost control
• Describe how project management software can assist in project cost
management
• Discuss considerations for agile/adaptive environments
The Importance of Project Cost Management

• IT projects have a poor track record for meeting budget goals

• 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
• Most important finding was the discovery of a large number of gigantic overages or
“black swans”; a high-impact event that is rare and unpredictable, but not improbable in
retrospect
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
• Program had problems due to incompatible systems, resistance from
physicians, and arguments among contractors about who’s responsible for
what
• Scrapped in 2011
What is Cost?

• Cost is a resource sacrificed or foregone to achieve a specific

objective or something given up in exchange
• Usually measured in monetary units like dollars that must be paid to acquire
goods and services
What is Project Cost Management? (1 of 2)
• Project cost management includes the processes required to ensure
that the project is completed within an approved budget
• 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
What is Project Cost Management? (2 of 2)
Basic Principles of Cost Management (1 of 3)

• Most members of an executive board better understand and are

more interested in financial terms than IT terms; they need to be
able to present and discuss project information in both
• Profits: revenues minus expenditures
• Profit margin: ratio of profits to revenues
• Life cycle costing: considers total cost of ownership, or development plus
support costs, for a project
• Cash flow analysis: determines estimated annual costs and benefits for a
project and resulting annual cash flow
Media Snapshot

• You cannot measure ROI unless you have a benefits measurement

process in place
• 2015 report by PMI findings
• Many organizations do not have a benefits measurement process
• 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 nine 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
two billion pounds of used electronics by 2020
Basic Principles of Cost Management (2 of 3)

• 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
Basic Principles of Cost Management (3 of 3)

• Additional concepts
• 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)
Advice for Young Professionals

• If you have never done so, take a class or do self-study in accounting,

financial statements, or financial management
• There are many online resources and short books available on the topics of
finance for the non-financial manager, how to use financial statements, or
similar content
• Financial specialists are often willing to help less-experienced people better
understand the key terminology of the financial field
Planning Cost Management

• The first step in project cost management is planning how the costs
will be managed throughout the life of the project
• The project team uses expert judgment, analytical techniques, and meetings
to develop the cost management plan
• Cost management plan includes:
• Level of accuracy
• Units of measure
• Organizational procedure links
• Control thresholds
• Rules of performance measurement
• Reporting formats
• Process descriptions
Estimating Costs (1 of 4)

• Project managers must take cost estimates seriously if they want to

complete projects within budget constraints
• Types of cost estimates
• Tools and techniques for estimating costs
• Typical problems associated with IT cost estimates
Estimating Costs (2 of 4)

Type of When Done Why Done Typical Range

Estimate
Rough order of Very early in the project Provides estimate of -50% to + 100%
magnitude life cycle, often 3–5 years cost for selection
(ROM) before project completion decisions
Budgetary Early, 1–2 years out Puts dollars in the -10% to +25%
budget plans
Definitive Later in the project, less Puts dollars in the -5% to +10%
than 1 year out budget plans

Table 7-1 Types of cost estimates

Estimating Costs (3 of 4)

• 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
• Should become more accurate as time progresses
• It is important to provide supporting details for estimates and updates to
project documents
• A large percentage of total project costs are often labor costs
Estimating Costs (4 of 4)

Department Year 1 Year 2 Year 3 Year 4 Year 5 Totals

Information 24 31 35 13 13 116
systems
Marketing 3 3 3 3 3 15
systems
Reservations 12 29 33 9 7 90

Contractors 2 3 1 0 0 6

Totals 41 66 72 25 23 227

Table 7-2 Maximum FTE by department by year

Cost Estimation Tools and Techniques

• 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
• Three-point estimates
• Involve estimating the most likely, optimistic, and pessimistic costs for items
• Parametric estimating
• Uses project characteristics (parameters) in a mathematical model to
estimate project costs
Typical Problems with IT Cost Estimates

• Reasons for inaccuracies

• Estimates are done too quickly
• People lack estimating experience
• Human beings are biased toward underestimation
• Management desires accuracy
How to Develop a Cost Estimate and Basis of
Estimates (1 of 3)
• 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 gather as much information as possible about
the project, ask how the organization plans to use the cost estimate, and
clarify the ground rules and assumptions
How to Develop a Cost Estimate and Basis of
Estimates (2 of 3)
How to Develop a Cost Estimate and Basis of
Estimates (3 of 3)
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 the number of internal
logical files (ILFs)—a group of logically related data that resides entirely
within the application boundary and is maintained through external inputs
Determining the Budget (1 of 2)

• Budgeting involves allocating the project cost estimate to individual

work items over time
• Material resources or work items are based on the activities in the WBS for
the project
• Important goal is to produce a cost baseline
• Time-phased budget that project managers use to measure and monitor cost
performance
Determining the Budget (2 of 2)
Controlling Costs

• Activities involved in controlling project costs

• 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
• Several tools and techniques assist in project cost control
• Expert judgment, data analysis, project management information systems,
and the to-complete performance index
Earned Value Management (EVM) (1 of 5)

• 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 scope, time, and cost goals
• Earned value management involves calculating three values for each
activity or summary activity from a project’s WBS
• Planned value
• Actual cost
• Earned value
Earned Value Management (EVM) (2 of 5)

Activity Week 1

Earned value (EV) 5,000

Planned value (PV) 10,000

Actual cost (AC) 15,000
Cost variance (CV) -10,000

Schedule variance (SV) -5,000

Cost performance index (CPI) 33%

Schedule performance index (SPI) 50%

Table 7-3 Earned value calculations for one activity after week 1
Earned Value Management (EVM) (3 of 5)

Term Formula

Earned value (EV) EV = PV of all completed work

Cost variance (CV) CV = EV - AC

Schedule variance (SV) SV = EV - PV

Cost performance index (CPI) CPI = EV/AC

Schedule performance index (SPI) SPI = EV/PV

Estimate at completion (EAC) EAC = BAC/CPI

Estimated to Complete (ETC) ETC = EAC - AC

Table 7-4 Earned value formulas

Earned Value Management (EVM) (4 of 5)

• Important concepts
• Cost variance (CV) is the earned value minus the actual cost
• Schedule variance (SV) is the earned value minus the planned value
• Cost performance index (CPI) is the ratio of earned value to actual cost
• Schedule performance index (SPI) is the ratio of earned value to planned
value
• Estimate at completion (EAC) is an estimated cost of completing a project
based on performance to date
• To-complete performance index (TCPI) is a measure of the cost performance
that must be achieved with the remaining resources to meet a specific goal
Earned Value Management (EVM) (5 of 5)
Global Issues (1 of 2)

• 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 7-7
• 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
Global Issues (2 of 2)
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
• Put all your projects in one database
• Prioritize the projects in your database
• Divide your projects into two or three budgets based on type of investment
• Automate the repository
• Apply modern portfolio theory, including risk-return tools that map project
risk on a curve
Using Project Management Software to Assist
in Project Cost Management (1 of 2)
• 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 can increase a project manager’s
effectiveness during each process of project cost management
• Many IT project managers use other tools to manage cost information
because they do not know that they can use project management software,
or they do not track costs based on a WBS, as most project management
software does
Using Project Management Software to Assist
in Project Cost Management (2 of 2)
• Recent Studies on PPM Software
• 2017 Gartner report says the market continues to grow, with annual sales
over $2.3 billion
• Forrester estimates ROIs of 250 percent from PPM tools
• Pfizer and Ford use PPM software to improve transparency of the many
projects they manage
Considerations for Agile/Adaptive
Environments
• AgileEVM is an adapted implementation of EVM
• Uses the Scrum framework artifacts as inputs, uses traditional EVM
calculations, and is expressed in traditional EVM metrics
• Requires a minimal set of input parameters
• Actual cost of a project, an estimated product backlog, a release plan that provides
information on the number of iterations in the release and the assumed velocity
• All estimates can be in hours, story-points, team days or any other consistent
estimate of size
• The critical factor is that it must be a numerical estimate of some kind
Chapter Summary

• Project cost management is a traditionally weak area of IT projects

• Project managers must understand several basic principles of cost
management to be effective in managing project costs
• Main processes
• Plan cost management
• Estimate costs
• Determine the budget
• Control costs
• Several software products can assist with project cost management