project cost estimation

The process of project cost estimation is vital. You quite literally cannot afford any mistakes, as errors may put you over budget and lead to project termination.

Before we discuss the project cost estimation, let’s check a real-world example.

A local government floated a multi-year contract to construct several metro train stations. Several contractors placed bids, and the lowest one got the project. 

During the execution phase, the project cost and schedule deviated from the baselines due to faulty cost estimation.  After several years, the gap became so substantial that the project was abandoned. 

This is just one example of estimated costs that were not reflective of actual costs. Low data quality, lack of data, or no refinement can all lead to incorrect estimations.

Longer projects can have shifting requirements; you need to factor them and update the baseline. In the beginning, you might factor assumptions and constraints incorrectly, so you just go back and validate them.

Project Cost Estimation 

The project cost estimation is a process where you predict the anticipated project cost. 

Put simply; cost estimation is used to forecast project costs. Project estimating activities are carried out in the early stage of the project lifecycle and then repeated as the project progresses. 

The initial estimations help management get an idea of the approximate project cost. As the project progresses, the scope gets clear, and then you can refine the estimation to get an accurate figure. This feature is known as progressive elaboration.

Estimation techniques can also help find resources, effort, duration, and the probability and impact of risks or benefits.

The estimation process can help you analyze:

  • Contingency reserve
  • Management reserve
  • Organizational budget and estimation
  • Vendor bid and analysis
  • Make or buy analysis
  • Risk probability, impact, urgency, and detectability analysis
  • Complexity scenario analysis
  • Organizational change management analysis
  • Capacity and capability demand estimation
  • Benefit definition
  • Success criteria definitions
  • Stakeholder management planning

Documents of assumptions, constraints, risks, constraints, level of detail, ranges, and confidence levels, etc., can help you with estimation. The level of confidence you can have in your estimation is influenced by information available on market dynamics, stakeholders, regulations, organizational capabilities, risk exposure, and level of complexity.

A Few Examples or Erroneous Project Cost Estimates

  • In 1914, the Panama Canal ran 23 million USD over budget compared to the 1907 plans.
  • In 1995, the Denver International airport opened 16 months late with extra spending of 2.7 billion USD.
  • In 1993, the London Stock Exchange abandoned the Taurus Program after more than 10 years of development. Taurus was 11 years late and 13,200 percent over budget, with no viable solution in sight.

What went wrong with these cost estimations?

Estimators lacked information initially and failed to revise costs and schedules as the project progressed. 

Proper estimations help determine a project’s feasibility by weighing the benefits against the costs involved.

How are Cost Estimations Done?

In traditional project management, if you have a well-defined scope of work, you will calculate the cost of all elements and add them to get the project budget. However, if you do not have detailed information, you can go for analogous or parametric estimation techniques.

The estimate includes the cost of quality, along with direct and indirect costs.

In Agile project management, the scope is defined at a high level; it is called epics or features. Before the beginning of the sprint, the epics or features are broken down into smaller components called user stories. 

Then, estimates are calculated based on the stories using various estimation techniques, e.g., playing a poker game.  

The project manager decides on the number of user stories to be delivered during the sprint planning meeting.

All project estimates involve assumptions, constraints, uncertainty, risk perceptions, and they should be refined as information becomes available.

For example, in the initial phase of the project lifecycle, you may have a rough order of magnitude (ROM) estimate between -25% to 75%. However, with progressive elaboration, you can narrow the accuracy to a range of -5% to 10%.

Roles of Stakeholders in Project Cost Estimations

  • Project Sponsor: authorizes the budget and lays out a high-level schedule.
  • Project Manager: responsible for the estimate, but not necessarily for estimating. The team helps them determine the project estimation. 
  • Portfolio and/or Program Managers: aggregate the project cost estimation across the projects within the portfolio or program.
  • Estimators and Subject Matter Experts: responsible for estimating a specific activity in the project. Estimators and SMEs can be individuals or team members of the organization.
  • Analysts: support the project team.
  • Senior Management: high-level stakeholders who review and approve the project estimates.

Project Cost Estimation Techniques

You can divide cost estimation techniques into three groups:

  • Quantitative
  • Relative
  • Qualitative

#1. Quantitative Project Cost Estimation Techniques

These techniques use numerical data to come up with an estimate. You cannot use these techniques when you’re missing data, experience or you have time restrictions.

Analogous Estimation: you can use an analogous technique when you have limited information, but the project is similar to a previous one. This is useful, and management needs a quick estimation for a feasibility study.

Parametric Estimation: based on historical information of a similar project but uses mathematical equations, like the cost of painting per square foot.

Bottom-Up Estimation: provides the most accurate result, but you can only use this method when all project details are available. Here, you calculate every component and add them up to get a final estimate. The bottom-up estimates technique takes the longest time and resources.

#2. Relative Project Cost Estimation

This technique is applied at the product backlog level instead of the sprint backlog level.

The relative project cost estimation technique is used when you have no experience, data, or have limited time. This is a high-level estimation technique that takes advantage of the human capability to compare.

Here the team members contrast the relative effort for the new tasks with the effort of the previously completed task.

Affinity Grouping: In this technique, similar items are grouped together. T-shirt sizing is the most commonly used. A specific item is estimated to be of size small, and it is compared to the next item. If larger, you will group as medium-sized.

Planning Poker: This technique is commonly used with Adaptive/Agile estimations. It uses a Fibonacci sequence to assign a point value to an epic, feature, user story, or backlog item. Every team member will have a set of cards to lay for each user story.

If there are any estimation deviations from multiple team members, the user story is re-discussed till they reach an agreement.

#3. Qualitative Project Cost Estimation Techniques

Some project elements are difficult to quantify. Qualitative estimates rely on understanding processes, behaviors, and conditions as perceived by individuals or groups. This technique can be used along with quantitative methods when perceptions are crucial.

Expert Judgement: This is a judgment based on expertise in an application area, knowledge area, discipline, industry.

Observation: Estimations sometimes can be based on observations (tacit knowledge).

Interviews: A formal or informal approach to extract information from stakeholders can be used in estimations.

Surveys: set of written questions designed to capture information from many respondents. This data is then used to formulate a common understanding of the estimates.

Conclusion

Estimating your project cost using expert judgment, analogous estimate, a guess, or relative estimation will not give you the most accurate picture, and you will need to use other techniques. 

In an Adaptive/Agile project, it is best to choose and refine a cost estimation technique as the project progresses. As the scope is clear in predictive projects, selecting an appropriate method is crucial to avoiding deviation at later stages.

Are you involved with the project cost estimation process? Please share your experiences through the comments section.