INFORMATION TECHNOLOGY

AND PROJECT MANAGEMENT

PROJECT COST
MANAGEMENT
1 Lecture Material 6
THE IMPORTANCE OF PROJECT
COST MANAGEMENT
 IT projects have a poor track record for meeting
budget goals
 The CHAOS studies found 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

2
WHAT IS COST?
 Cost is a resource sacrificed to achieve a specific
objective
 Costs are usually measured in monetary units like
dollars

3
BASIC PRINCIPLES OF COST
MANAGEMENT
 Most members of an executive board better
understand and are more interested in financial
terms than IT terms, so IT project managers must
speak their language (Business language!)
 Profits are revenues minus expenditures
 Profit margin is the ratio of revenues to profits
 Cash flow analysis determines the estimated annual
costs and benefits for a project and the resulting annual
cash flow

4
TABLE 7-1: COST OF SOFTWARE DEFECTS

5
5

Information Technology Project Management, Fifth Edition,

Copyright 2007
BASIC PRINCIPLES OF COST
MANAGEMENT
 Tangible costs or benefits are those costs or
benefits that an organization can easily
measure in dollars.
 For example, if a company complete a study/research
for RM100,000, the tangible cost of the study/research
is RM100,000.

 Intangible costs or benefits are costs or

benefits that are difficult to measure in
monetary terms.
 For example, suppose you and few other people spent
some time using the university library, computers,
books, and other resources to research areas related
to the study. Although your hours of work and
university-owned resources were not billed to the 6
project, they could be considered intangible costs.
BASIC PRINCIPLES OF COST
MANAGEMENT
 Direct costs are costs that can be directly
related to producing the products and services
of the project.
 For example, salaries of people working full-time on
the project and cost of software and hardware
purchased specifically for the project are direct costs.
Project managers can control direct costs better than
any other costs.

 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.
 For example, costs of electricity, paper towels, and so
on in a large building housing a thousand employees 7
who work on many projects would be indirect costs.
BASIC PRINCIPLES OF COST
MANAGEMENT
 Sunk cost is money that has been spent in
the past; just like sunken ship that can never
be returned; when deciding what projects to
invest in or continue, you should not include
sunk costs. Sunk costs should be forgotten.
 For example, suppose a company had spent RM1
million on a project over the past three years to
create a geographic information system (GIS), but
they never produced anything valuable. If the
government were evaluating what projects to fund
next year and someone suggested that they keep
funding the GIS project because they had already
spent R1 million on it, he/she would be incorrectly
making sunk cost a key factor in the project
selection decision. 8
BASIC PRINCIPLES OF COST
MANAGEMENT (CONTINUED)
 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.
 For example, suppose a company’s project would
potentially produce 1000 handheld devices for Tesco
that could run the new software and access information
via Wifi. The cost of the first handheld device would be
much higher than the cost of the 1000th unit.
 For example, the first time a new employee performs a
specific task, it will probably take longer than the 10th
time that employee performs a very similar task.
 Learning curve theory should help estimate costs
on projects involving the production of large
quantities of items. 9
BASIC PRINCIPLES OF COST
MANAGEMENT (CONTINUED)
 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
 For example, if an organization knows it has a
20% rate of turnover for IT personnel for a
given project/year, it should include
contingency reserves to pay for recruiting and
10
training costs for new IT personnel.
BASIC PRINCIPLES OF COST
MANAGEMENT (CONTINUED)
Management reserves allow for future
situations that are unpredictable
(sometimes called unknown
unknowns)
 For example, if a project manager gets sick for
two weeks or an important supplier goes out
of business, management reserve could be set
aside to cover the resulting costs.

11
WHAT IS PROJECT COST
MANAGEMENT?
 Project cost management includes the processes
required to ensure that the project is completed
within an approved budget

12
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

13
PROCESS 1: COST
ESTIMATING
 One of the main outputs of project cost
management is a cost estimate.
 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
 The three basic types of estimates include the
following: Rough Order of Magnitude (ROM)
estimate or guesstimate, Budgetary estimate,
and Definitive estimate 14
COST ESTIMATING
 ROM estimate
 Many IT professionals and project managers automatically
double estimates for software development because of the
history of cost overruns on IT projects
 Budgetary (cost itemized) estimate
 Is used to allocate money into an organization’s budget.
 Definitive (most reliable) estimate
 Provides an accurate estimate of project costs. Definitive
estimates are used for making many purchasing decisions for
which accurate estimates are required and for estimating final
project costs. For example, if a project involves purchasing
1000 PCs from an outside supplier in the next three months, a
definitive estimate would be required to aid in evaluating
supplier proposals and allocating the funds to pay the chosen
supplier.
15
TABLE 7-2: TYPES OF COST ESTIMATES

16

Information Technology Project Management, Fifth Edition,

Copyright 2007
COST MANAGEMENT PLAN
 A cost management plan is a document that
describes how the organization will manage cost
variance on the project
 A large percentage of total project costs are often
labor costs, so project managers must develop
and track estimates for labor

17
TABLE 7-3: MAXIMUM DEPARTMENTAL
HEADCOUNTS BY YEAR (NORTHWEST
AIRLINES)

18

Information Technology Project Management, Fifth Edition,

Copyright 2007
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. It is less costly than other
techniques but it is also less accurate (too low an estimate)
in situations whereby the project to be estimated involves a
new programming language or working with a new type of
hardware or network. Accuracy success factors depend on :
expert judgment.
 Bottom-up estimates or activity-based costing:
involve estimating individual work items or activities and
summing them to get a project total. Accuracy success
factors depending on: size of individual work items and
experience of estimators.
19
COST ESTIMATION TOOLS AND TECHNIQUES
 Parametric modeling: uses project parameters in a
mathematical model to estimate project costs.
Accuracy success factors depend on: programming
language the project is using, level of expertise of the
programmers, size and complexity of data involved,
number of inputs and outputs, and the number of files
maintained. One popular parametric model is the
Constructive Cost Model (COCOMO).

20
SAMPLE COST ESTIMATION USING
PARAMETRIC MODELING

21
TYPICAL PROBLEMS WITH IT COST
ESTIMATES
 Estimates are done too quickly and before clear system
requirements have been produced.
 Lack of estimating experience, especially for larger
projects.
 Human beings are biased toward underestimation. For
example, senior IT professionals and project managers
might make estimates based on their own abilities and
forget that many junior people will be working on a
project. Therefore, the low budgets given to the project
will cause bias view of the project by team members.

22
TYPICAL PROBLEMS WITH IT COST
ESTIMATES
 Management might ask for an estimate but really
desire a more accurate (or shorter) number in
reality. It is important for project managers to help
develop good cost and schedule estimates and to
use their leadership and negotiation skills to stand
by those estimates despite facing conflicts.

23
SAMPLE COST ESTIMATE
 Before creating an estimate, know what it will be
used for, gather as much information as possible,
and clarify the ground rules and assumptions for
the estimate
 If possible, estimate costs by major WBS
categories

24
FIGURE 7-2: SURVEYOR PRO PROJECT COST
ESTIMATE

25

Information Technology Project Management, Fifth

Edition, Copyright 2007
PROCESS 2: COST BUDGETING
 Cost budgeting involves allocating the project cost
estimate to individual work items over time
 The WBS is a required input to the cost budgeting
process since it defines the work items
 An important goal is to produce a cost baseline
A time-phased budget that project managers use to
measure and monitor cost performance

26
FIGURE 7-4: SURVEYOR PRO PROJECT
COST BASELINE

27
*Numbers are rounded, so some totals appear to be off.

27

Information Technology Project Management, Fifth

Edition, Copyright 2007
PROCESS 3: 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
 Performance review meetings can be a powerful
tool for helping to control project costs.

28
COST CONTROL
 People often perform better when they know they
must report on their progress.
 An important tool for cost control is performance
measurement.
 Although many general accounting approaches
are available for measuring cost performance,
Earned Value Management (EVM) is a very
powerful cost control technique that is unique to
the field of project management.

29
EARNED VALUE MANAGEMENT
TERMS
 The planned value (PV), is that portion of the
approved total cost estimate planned to be spent
on an activity during a given period
 Actual cost (AC), is the total of direct (and
indirect) costs incurred in accomplishing work on
an activity during a given period
 The earned value (EV), is an estimate of the
value of the physical work actually completed to
date

30
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
 For example, suppose the server installation was
halfway completed by the end of week 1; the rate
of performance would be 50% because by the end
of week 1, the planned schedule reflects that the
task should be 100% complete and only 50% of
that work has been completed

31
TABLE 7-4 EARNED VALUE CALCULATIONS
FOR ONE ACTIVITY AFTER WEEK ONE

32
32

Information Technology Project Management, Fifth

Edition, Copyright 2007
RULES OF THUMB FOR EARNED
VALUE NUMBERS
 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
than planned (over budget) or taking longer
than planned (behind schedule)

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

34