Chapter 7: Project Cost Management Information Technology

Chapter 7: Project Cost Management Information Technology Project Management

Learning Objectives Understand the importance of project cost management. Explain basic project cost management principles, concepts, and terms. Discuss different types of cost estimates and methods for preparing them. Information Technology Project Management, Thomson Technology 2

Learning Objectives Understand the processes involved in cost budgeting and preparing a cost estimate and budget for an information technology 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. Information Technology Project Management, Thomson Technology 3

The Importance of Project Cost Management IT projects have a poor track record for meeting budget goals. The CHAOS studies found that the average cost overrun (the additional percentage or dollar amount by which actual costs exceed estimates) ranged from 180 percent in 1994 to 43 percent in 2002; other studies found overruns to be 33-34 percent Information Technology Project Management, Thomson Technology 4

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, such as dollars. Project cost management includes the processes required to ensure that the project is completed within an approved budget. Information Technology Project Management, Thomson Technology 5

Project Cost Management Processes Cost estimating: Developing an approximation or estimate of the costs of the resources needed to complete a project. Cost budgeting: Allocating the overall cost estimate to individual work items to establish a baseline for measuring performance. Cost control: Controlling changes to the project budget. Information Technology Project Management, Thomson Technology 6

Basic Principles of Cost Management Most members of an executive board have a better understanding and are more interested in financial terms than IT terms, so IT project managers must speak their language. Profits are revenues minus expenses. Life cycle costing considers the total cost of ownership, or development plus support costs, for a project. Cash flow analysis - a method to determine the estimated annual costs and benefits for a project and the resulting annual cash flow. Information Technology Project Management, Thomson Technology 7

Table 7-1. Cost of Software Defects* It is important to spend money up-front on IT projects to avoid spending a lot more later. (Ex: automobiles defect after sales?) Information Technology Project Management, Thomson Technology 8

Basic Principles of Cost Management 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. electricity 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. salaries Information Technology Project Management, Thomson Technology 9

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). Information Technology Project Management, Thomson Technology 10

Cost Estimating 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. Information Technology Project Management, Thomson Technology 11

Table 7-2. Types of Cost Estimates Information Technology Project Management, Thomson Technology 12

Cost Management Plan A cost management plan is a document that describes how the organization will manage cost variances on the project. A large percentage of total project costs are often labor costs, so project managers must develop and track estimates for labor. Describes how to respond to proposals from suppliers that are lower or higher than estimates. It comes after definitive estimates. Information Technology Project Management, Thomson Technology 13

Table 7-3. Maximum Departmental Headcounts by Year A large percentage of the costs of many IT projects are human resource costs. Information Technology Project Management, Thomson Technology 14

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. (Ex: 50/LOC based on SW language, expertise, complexity, size, etc) Computerized tools: Tools, such as spreadsheets and project management software, that can make working with different cost estimates and cost estimation tools easier. Information Technology Project Management, Thomson Technology 15

Constructive Cost Model Barry Boehm helped(COCOMO) develop the COCOMO models for estimating software development costs. They are popular parametric models. Parameters include: Function points: Technology-independent assessments of the functions involved in developing a system. (Ex: number of inputs/outputs, files, etc). This helps to determine . Source Lines of Code (SLOC): A human-written line of code that is not a blank line or comment. Boehm suggests that only parametric models do not suffer from the limits of human decision-making. Information Technology Project Management, Thomson Technology 16

Typical Problems with IT Cost Estimates Developing an estimate for a large software project is a complex task that requires a significant amount of effort. Estimates are done too quickly People who develop estimates often do not have much experience. Human beings are biased toward underestimation. Management might ask for an estimate, but really desire a bid to win a major contract or get internal funding. Management desires accuracy Information Technology Project Management, Thomson Technology 17

Sample Cost Estimate This example describes how to create a cost estimate for the Surveyor Pro project described in the opening case in this chapter. Before creating an estimate, know what it will be used for, gather as much information about the project 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 change and document the estimate. Information Technology Project Management, Thomson Technology 18

Figure 7-1. Surveyor Pro Project Cost Estimate Information Technology Project Management, Thomson Technology 19

Figure 7-2. Surveyor Pro Software Development Estimate Information Technology Project Management, Thomson Technology 20

Cost Budgeting Cost budgeting involves allocating the project cost estimate to individual work items over time. The WBS is a required input for the cost budgeting process because 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. Information Technology Project Management, Thomson Technology 21

Figure 7-3. Surveyor Pro Project Cost Baseline Information Technology Project Management, Thomson Technology 22

Cost Control 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. Information Technology Project Management, Thomson Technology 23

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. Information Technology Project Management, Thomson Technology 24

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. Information Technology Project Management, Thomson Technology 25

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 using this 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 percent (50/100) 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. Information Technology Project Management, Thomson Technology 26

Table 7-4. Earned Value Calculations for One Activity After Week One Information Technology Project Management, Thomson Technology 27

Table 7-5. Earned Value Formulas Information Technology Project Management, Thomson Technology 28

Rules of Thumb for Earned Value Numbers Negative numbers for cost and schedule variance indicate problems in those areas. A CPI or SPI that is less than 100 percent indicates problems. Problems mean the project is costing more than planned (over budget) or taking longer than planned (behind schedule). Information Technology Project Management, Thomson Technology 29

Figure 7-4. Earned Value Calculations for a One-Year Project After Five Months Information Technology Project Management, Thomson Technology 30

Figure 7-5. Earned Value Chart for Project after Five Months If the EV line is below the AC or PV line, there are problems in those areas. Information Technology Project Management, Thomson Technology 31

Project Portfolio Management Many organizations collect and control an entire suite of projects or investments as one set of interrelated activities in a portfolio. Project portfolio management has five levels: 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. Information Technology Project Management, Thomson Technology 32

Benefits of Portfolio Management Schlumberger saved 3 million in one year by organizing 120 information technology projects into a portfolio META Group research shows that: Organizations that evaluate information technology projects by what their business impacts are and what their potential business values will be implement projects that result in 25 percent more improvement to the bottom line Business executives state that using project portfolio management allows managers to make decisions faster and with more confidence Information Technology Project Management, Thomson Technology 33

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. Information Technology Project Management, Thomson Technology 34

Figure 7-6. Sample Project Portfolio Management Screen Showing Project Health Information Technology Project Management, Thomson Technology 35

Chapter Summary Project cost management is traditionally a weak area in IT projects, and project managers must work to improve their ability to deliver projects within approved budgets. Main processes include: Cost estimating Cost budgeting Cost control Information Technology Project Management, Thomson Technology 36