Cost Estimating – Part 2

This post is Part 2 on Cost Estimating. In case you missed it, here is Cost Estimating – Part 1.

The seventh principle of Project Management is “Minimize total cost, not the price of resources”. We need to discuss the total cost if we are to adhere to this principle. Although there is wonderful guidance in the PMBOK® Guide, the best practices for the Federal environment comes from the GAO Cost Estimating and Assessment Guide. In this blog I will refer to this as “the Cost Estimating Guide”.

When it comes to estimating, we want to answer the question, “Where did you get those numbers?” with defensible accuracy. The Cost Estimating Guide defines four process groups and twelve process steps necessary to attain accurate cost estimates.

“Certain best practices should be followed if accurate and credible cost estimates are to be developed. These best practices represent an overall process of established, repeatable methods that result in high-quality cost estimates that are comprehensive and accurate and that can be easily and clearly traced, replicated, and updated.”

Initiation & Research – Identify your audience, what you are estimating, and why you are estimating it.

1. Define the estimate’s purpose
Determine the estimate’s purpose, required level of detail, and overall scope. Determine who will receive the estimate. As defined by the PMBOK® Guide, is this a Preliminary, Budgetary, or Definitive estimate?

2. Develop the estimating plan
Determine the cost estimating team and develop its master schedule. Determine who will do the independent cost estimate. Outline the cost estimating approach and develop the estimate timeline. The estimating plan should be added to the Project Management Plan.
Assessment – Cost assessment steps are iterative and can be accomplished in varying order or concurrently.

3. Define the program
In a technical baseline description document, identify the program’s purpose and its system and performance characteristics and all system configurations. Any technology implications and program acquisition schedule and acquisition strategy and relationship to other existing systems, including predecessor or similar legacy systems. Support (manpower, training, etc.) and security needs and risk items should be included. System quantities for development, test, and production and deployment and maintenance plans should be documented.

4. Determine the estimating structure
Define a work breakdown structure (WBS) and describe each element in a WBS dictionary. Choose the best estimating method for each WBS element and Identify potential cross-checks for likely cost and schedule drivers. Develop a cost estimating checklist.

5. Identify ground rules and assumptions
Clearly define what the estimate includes and excludes. Identify global and program-specific assumptions, such as the estimate’s base year, including time-phasing and life cycle. Identify program schedule information by phase and program acquisition strategy and any schedule or budget constraints, inflation assumptions, and travel costs.
Specify equipment the government is to furnish (GFE) as well as the use of existing facilities or new modification or development. Identify prime contractor and major subcontractors and determine technology refresh cycles, technology assumptions, and new technology to be developed. Define commonality with legacy systems and assumed heritage savings. Describe effects of new ways of doing business and include them in this section.

6. Obtain the data
Create a data collection plan with emphasis on collecting current and relevant technical, programmatic, cost, and risk data and investigate and document possible data sources. Collect data and normalize them for cost accounting, inflation, learning, and quantity adjustments and analyze the data for cost drivers, trends, and outliers and compare results against rules of thumb and standard factors derived from historical data. Interview data sources and document all pertinent information, including an assessment of data reliability and accuracy. Store data for future estimates as estimates are iterative.

7. Develop the point estimate and compare it to an independent cost estimate
Develop the cost model, estimating each WBS element, using the best methodology from the data collected, and including all estimating assumptions. Express costs in constant year dollars and time-phase the results by spreading costs in the years they are expected to occur, based on the program schedule. Sum the WBS elements to develop the overall point estimate.
Validate the estimate by looking for errors like double counting and omitted costs and compare estimate against the independent cost estimate and document where and why there are differences. Perform cross-checks on cost drivers to see if results are similar. Update the model as more data become available or as changes occur and compare results against previous estimates.
Analysis – The confidence in the point or range of the estimate is crucial to the decision maker.

8. Conduct Sensitivity Analysis
Test the sensitivity of cost elements to changes in estimating input values and key assumptions and identify effects on the overall estimate of changing the program schedule or quantities. Determine which assumptions are key cost drivers and which cost elements are affected most by changes.

9. Conduct risk and uncertainty analysis
Determine and discuss with technical experts the level of cost, schedule, and technical risk associated with each WBS element. Analyze each risk for its severity and probability and develop minimum, most likely, and maximum ranges for each risk element. Determine type of risk distributions and reason for their use. Ensure that risks are correlated and use an acceptable statistical analysis method (e.g., Monte Carlo simulation) to develop a confidence interval around the point estimate.
After identifying the confidence level of the point estimate, identify the amount of contingency funding and add this to the point estimate to determine the risk-adjusted cost estimate. Recommend that the project or program office develop a risk management plan to track and mitigate risks.

10. Document the estimates
Document all steps used to develop the estimate so that a cost analyst unfamiliar with the program can recreate it quickly and produce the same result. Document the purpose of the estimate, the team that prepared it, and who approved the estimate and on what date and describe the program, its schedule, and the technical baseline used to create the estimate.
Present the program’s time-phased life-cycle cost. Discuss all ground rules and assumptions, include auditable and traceable data sources for each cost element and document for all data sources how the data were normalized. Describe in detail the estimating methodology and rationale used to derive each WBS element’s cost (prefer more detail over less). Also describe the results of the risk, uncertainty, and sensitivity analyses and whether any contingency funds were identified. Document how the estimate compares to the funding profile. Track how this estimate compares to any previous estimates.
Presentation – Documentation and presentation make or break a cost estimating decision outcome.

11. Present estimate to management for approval
Develop a briefing that presents the documented life cycle cost estimate which includes an explanation of the technical and programmatic baseline and any uncertainties. Compare the estimate to an independent cost estimate (ICE) and explain any differences. Compare the estimate (life-cycle cost estimate (LCCE)) or independent cost estimate to the budget with enough detail to easily defend it by showing how it is accurate, complete, and high in quality. Focus in a logical manner on the largest cost elements and cost drivers.
Make the content clear and complete so that those who are unfamiliar with it can easily comprehend the competence that underlies the estimate results. Make backup slides available for more probing questions and act on and document feedback from management and stakeholders. Request acceptance of the estimate. Your organization may have standardized presentation methods or you may be a trail blazer here.

12. Update the estimate to reflect actual costs/charges
Update the estimate to reflect changes in technical or program assumptions or keep it current as the program passes through new phases or milestones. Replace estimates with EVM EAC and independent estimate at completion (EAC) from the integrated EVM system and report progress on meeting cost and schedule estimates. Perform a post mortem and document lessons learned for elements whose actual costs or schedules differ from the estimate. Document all changes to the program and how they affect the cost estimate.

This cost estimating process creates defensibility, accuracy, and credibility. I suggest that you download a copy of the GAO Cost Estimating and Assessment Guide to your local desktop or laptop (or whatever device you are currently using for Project Management) and have it available for reference. It is a well written and understandable document. It will take you to greater depth on each of the steps. I’ve only exposed the process in this blog.

Happy Estimating!