Estimate Costs

00:01 Hello and welcome.

00:03 This module focuses on the estimate costs process and the PMBOK guide.

00:10 It's very important that you pay particular attention to this module because there will undoubtedly be questions in the exam about cost estimating techniques, and as such, the difficulty level is rated as medium because you may not have heard of or used a lot of these cost estimating techniques. But none of them are particularly difficult and hence the memorization required is low.

00:40 The estimate costs process is one of four cost management knowledge area processes in total and the second of three planning processes.

00:51 The first planning process was planned cost management, which provided us with our cost management plan and we're going to use that cost management plan to estimate our costs because it's going to provide guidance on the particular estimating techniques we are going to use and the level of estimating we look to achieve.

01:14 Of course, once we have our individual cost estimates, we can take those and also our project schedule, combine those two things together and develop or determine our project budget.

01:28 Once we have our project budget and our individual cost estimates, we can then control costs by looking at each of them and compare what's actually occurring in terms of costs and budget and see if there's a variance between them.

01:47 The particular domain task that the estimate cost process helps us understand better is the planning task to which says develop the cost management plan based on the project scope, schedule resources approved project charter and other information using estimating techniques in order to manage project costs.

02:10 And in fact, this particular planning task covers all three of the project cost management knowledge area planning processes, so it covers the developed cost management plan. It covers the estimate costs, and it also covers the determined budget process.

02:33 The key theme of this process is that it focuses on the development of individual cost estimates using a variety of cost estimating techniques and the particular cost estimating technique that you choose to use will reflect the level of information you have and the level of certainty you desire.

02:55 Keep that in mind.

02:57 Estimating is simply a forecast of a likely future state and it's only as good as the technique you use and the information that you have at hand.

03:09 The more information you have at hand, the better your estimate will be.

03:14 Often at the beginning of a project, we don't have all the information at hand because of progressive elaboration.

03:21 So our cost estimates may have a greater degree of uncertainty at the beginning of the project. And as we move through the project, they'll become more refined and more accurate. In order to estimate our costs, these are the particular inputs that we could use if they were appropriate. The first one is particularly necessary, though, and that's our cost management plan, which as we know is an output from the plan. Cost management process and the cost management plan itself provides guidance to us on exactly how we're going to estimate costs.

04:01 It's going to contain information about the particular techniques to use the software, to use the personnel, to use the level of acceptable uncertainty and how to deal with that uncertainty.

04:14 We may also choose to use the human resource management plan because typically. Personnel on a project make up the largest cost, so we will want to know how the management of people and our project will affect our costs.

04:31 And this could be such things as employment conditions or holiday pay or vacations.

04:38 All of these things may impact upon our project costs, of course, in order to accurately estimate our project costs.

04:46 We'll also want our scope baseline and remember, this is an output from one of the scope management.

04:52 planning areas develop scope and the scope baseline includes three key elements, and they are the project scope statement, the work breakdown structure and the Work Breakdown Structure Dictionary. So with all of that information, we've got an excellent description of all the things we're trying to estimate in terms of cost. The project schedule, which is an output from the developed schedule process as necessary as well in terms of the timing of costs.

05:28 How much of the costs are going to be incurred early on on the project? How much of the costs are going to be incurred later on the project because there can be a time value to money as well, and we may need to take that into account.

05:41 In applying and developing contingencies, for example, with our cost estimates.

05:47 We may also want our risk register, because if we've done it comprehensively, it will include an analysis of cost uncertainty on our project.

06:00 And we need to take a look at that uncertainty and how it affects our cost estimates. If there was no uncertainty in our project, our estimates would probably be highly accurate and not subject to change throughout the project.

06:14 If, however, we've identified many areas of uncertainty or risk, each of those could impact upon our individual cost estimate or the range of estimates that we give the final two inputs our enterprise environmental factors, which in this case will include such things as market conditions.

06:36 The rate of inflation.

06:39 Employment conditions, all of which could adversely affect our individual cost estimates, as is also the rate of borrowing or financing our project organizational process assets that may be useful as an input include our particular organizational cost, estimating checklists, our project management methodology and sometimes our finance team may give us some advice and processes to follow for cost estimating as well.

07:13 So once we have those particular inputs, we can then move on to select from the following list the appropriate tools and techniques to help us develop our individual cost estimates.

07:27 Now the great thing about these tools and techniques I'm about to show you is many of them we also saw in the development of individual time estimates. So if you remember the process estimate, activity durations from time management.

07:43 Many of these estimating techniques also appeared there.

07:48 The first tool and technique that we will use will be exPERT judgment.

07:53 And remember, you're an exPERT about project costs.

07:56 Your project team members are an exPERT about project costs.

08:01 You may also choose to consult others, particularly professionals like quantity surveyors, whose job it is to do accurate cost estimating. You may also choose to consult other exPERTs, like accountants or members of your finance team, for other aspects of cost estimates.

08:20 Other tools and techniques that you may choose to use include analysis, estimating now analysis estimating simply means taking an analogy or something similar from the past.

08:32 And using that to give yourself a new estimate.

08:38 Sometimes analysis is to make it can be quite inaccurate, but it can always be done quickly. Sometimes it can actually be quite accurate, particularly if you've done the recent activity in the last three to six months.

08:51 So, for example, in terms of cost estimating, you could use analysis, estimating and say six months ago we did a project where this component cost us $3000 for this project.

09:05 We need two of these components.

09:07 Therefore, our cost estimate is $6000.

09:11 That's an analogous estimate.

09:14 A parametric estimate, on the other hand, involves taking two numbers and multiplying them together.

09:20 Remember that the word metric is Latin for number.

09:25 So we need two numbers.

09:27 So for example, we could find out that a cubic meter of concrete cost $200 a cubic meter.

09:35 And we need 10 cubic meters.

09:38 And therefore our parametric estimate would be 10 times 200 would be $2000 for the concrete that we need.

09:47 Bottom up estimating is generally considered to be the most accurate, but also the most time consuming because it relies heavily on the existence of a work breakdown structure because the bottom up part of this term refers to going all the way down to the lowest level of your work breakdown structure, whether it's work, package level or activity level, and then for each of those giving a reliable cost estimate.

10:18 And then aggregating or adding up each of those estimates upwards to give a combined total of your cost estimate.

10:27 Obviously, as you can see, it can be very accurate, but as I said, it takes extra time and energy and you must have a work breakdown structure in place to be able to do that.

10:42 A theft total technique that you may find useful is the three point estimating technique sometimes called the PERT formula PERT P-E-R-T standing for the program evaluation and review technique. And we'll look closely at some examples of the three point estimating technique shortly.

11:02 Other tools and techniques that we may find useful include reserves analysis, obviously a cost estimate is just a guess at what you think an activity will cost at some point in the future if that cost estimate is to be incurred in a week's time.

11:20 It might be quite accurate, but if it's to be incurred in a year's time, it may not be so accurate. And therefore you may need to calculate a reserve a contingency reserve in this case, which is for known unknowns in your project. There are many ways to calculate contingency reserve.

11:38 One of the easiest is to simply take historical information from previous projects about how accurate your cost estimates were and apply those to the current estimates. So, for example, you may have historical information gathered over the last two years that says that you routinely underestimate your costs by 20 per cent.

12:02 What a fantastic lesson to have learned, and now you can use that to routinely add 20 per cent to your cost estimates as a contingency reserve. Remember that contingency reserves are always included in the approved project budget.

12:19 Now this may differ from your actual experience, but for the purposes of the exam, the contingency reserve should be treated as under the control of the project manager and approved as part of a total project budget.

12:33 The other aspect of contingency reserves that you may not currently follow is that if that contingency or that uncertainty doesn't manifest, you must return the contingency reserve to the organization and not simply put it aside to use at some point in the future.

12:50 Another aspect or tool or technique that we could use is the cost of quality. Now we see this again when we come to plan quality management, perform quality assurance and control quality processes and the quality management knowledge area. This is the sincere consideration that must be given to decisions about quality and how they impact upon your individual cost estimates.

13:15 Sometimes, if the cost estimates are getting too high, you may be asked to reduce the quality of what you're producing in an effort to reduce project costs.

13:27 Well. Reducing the quality certainly reduces.

13:33 The cost of the estimate, but it doesn't reduce the actual cost.

13:38 It simply transfers it to further on in the product life cycle.

13:44 And the cost of poor quality will manifest and higher maintenance or higher operational costs or even impact negatively on your reputation and lose your business in the future.

13:57 So if assessing the cost of quality in an attempt to lower your project cost estimates, keep in mind that it's not really lowering the cost.

14:07 It's simply transferring the cost to outside of the project life cycle to further points and the product life cycle.

14:16 Another total technique that you may choose to use is project management software.

14:22 Obviously, we wouldn't expect you to have a notebook open and write down all your project cost estimates and use a calculator to add them all up and continually change them, so we turn to project management software.

14:33 And there's many versions of very, very good project management software out there in the market, ranging from simple spreadsheets up to dedicated project software right up to ERP systems that control all all of an organization's finances.

14:50 Another total technique that you will find useful is called vendor bed analysis.

14:56 This is where you go out to the external marketplace, to external contractors, and you ask them for a price or a cost estimate on a particular piece of work.

15:09 Now, before receiving their price back, you develop an expected range of that price with vendor bid analysis.

15:19 You then look at their bid or their price and you make sure they've captured everything they should have captured.

15:26 Make sure they're not deliberately bidding low because they know that you've missed something out in the statement of work to be performed as part of that external work. So vendor bid analysis as you double checking and developing a reasonable expectation of the price you will receive from external vendors as part of developing individual cost estimates.

15:49 You may also choose to use group decision making techniques, obviously compiling a whole range of individual cost estimates.

15:57 Involves talking to a whole range of exPERTs, sometimes in groups.

16:01 And how do you get people in groups to make decisions effectively? Well, it starts with getting them to think about all the possible options with group creativity techniques like brainstorming, thinking laterally, the nominal group technique where you get the group to think about the decisions going forward and which ones you will follow and which ones you're not.

16:21 And of course, the Delphi technique where you ask exPERTs anonymously for their opinion in order to avoid bullying, groupthink or peer pressure. And once you have those range of decisions put before you that you can then use specific decision making techniques like consensus, majority or dictatorship through a single leader to make the decisions.

16:45 But it's always a good idea as part of your cost management plan to make these decisions early on.

16:54 Let's take a closer look at some of those tools and techniques I've already mentioned analogous estimating.

17:01 Analogous estimating and simply taking an analogy from a previous project and extrapolating from that.

17:07 What the current cost estimate will be.

17:10 So for example, you could say that on a previous project, the new servers cost $20,000 and we need twice as many on this project, and therefore our analysis estimate is $40,000.

17:24 Obviously, the more recent that you've done the work, the better the analogy will be. Using an analogous estimate of a project five years in the past won't be very accurate. Parametric estimating is taking a unit measure and multiplying it by a known amount to get a particular cost estimate.

17:46 So for example, as I've already mentioned, if we find out that concrete cost $200 per cubic meter and you need 10 cubic meters, you're parametric cost estimate is $2000 simply two hundred times ten. That's a parametric estimate.

18:05 The particular form of estimate you choose to use will reflect the level of information you have, the level of time you have and the level of certainty you want.

18:14 Please keep that in mind.

18:17 Now we move on to some formulas now, we've already seen this particular formula. The three point estimate.

18:25 In the development of our project schedule with estimate activity durations there, we saw the formula with a little T rather than a little C, the T standing for time.

18:37 And this instance, the Little C, stands for cost.

18:41 I choose to remember it with that eight of the T or the C.

18:44 So the formula is simply our optimistic estimate, plus four times our most likely estimate, plus our pessimistic estimate divide by six in this case to give us a weighted average.

18:59 There is a simpler form of this equation that gives us a simple average, and that is simply to take our optimistic.

19:07 Add it to our most likely.

19:09 Add that to our pessimistic and then simply divide by three.

19:12 That's a simple average form of the same formula, but the one that we're interested in is the one that gives a greater weighting to our most likely cost estimate. And as with the simple average, we had three numbers and we divided by three to get the average.

19:30 And this case, we actually have six numbers.

19:33 If you take a look, this one optimistic number one pessimistic number.

19:38 And this four most likely numbers.

19:41 So we have six numbers in total.

19:43 Hence, why we divide by six.

19:46 We can also calculate the standard deviation, and this is useful for determining a range of certainty.

19:54 Are we 68 per cent certain? 95 per cent certain, 99 per cent certain of our range of cost estimates? And to calculate this, we use a simple formula called a heuristic or rule of thumb.

20:07 This is isn't actually the formula for calculating standard deviation.

20:12 That formula is a fairly lengthy formula known only to statisticians for the purposes of the exam.

20:20 We use pessimistic minus optimistic, divided by six, and it gives us something close enough and of use to us.

20:30 Another variable that we could calculate would be the variance, which is simply the standard deviation squared.

20:38 Now, for the purposes of the exam, you need to read the question carefully.

20:43 The question may give you the variance and ask you to calculate two standard deviations either side of the mean.

20:50 So the first thing you need to do is to take that variance and determine the square root of it. So if your variance was $25, the square root of that would be $5.

21:03 That's your standard deviation.

21:06 So let's take a look at some examples of the three point or PERT estimating technique. Let's say we have a pessimistic estimate of one hundred and fifty dollars to complete this activity, yet we've got an optimistic estimate of $50 to complete this activity.

21:24 But a most likely estimate of $80 to complete this activity.

21:29 Of course, when presented with this range of estimates, the challenge is how do we justify which one we use? And this is where the three point estimating technique.

21:39 Shows its strength, what we do using the formula is we add our optimistic $50 to four times our most likely, which is $80 to our pessimistic of one hundred and fifty dollars divide all of those by six.

21:57 So we have $50 plus $320 plus $150 divided by six, which gives us $520 divide by six, which gives us a three point estimate of $86.66.

22:15 And that's the figure we could include.

22:18 But moving on for that to standard deviations, if we wanted to take a look and say, well, we know that the mean is $86.66 Or $86.66, what's the range of certainty that you have that you can deliver that cost or that activity for that cost? So we're going to use standard deviation here, and we need to know that one standard deviation.

22:44 Either side of the mean equals sixty eight percent of the population.

22:49 Two standard deviations either side of the mean equals 95 per cent of the population three standard deviations either side.

22:58 The mean equals 99 per cent of the population.

23:02 And as a point of interest, once we get to quality management, you'll see that six standard deviations, or Six Sigma, as a quality tool equals 99.999 Per cent of the population.

23:16 But for the purposes of three point estimating, we're only interested in one, two and three standard deviations either side of the mean.

23:23 So let's use our previous example where we had a mean of $86.66. But remember, this was built up on a pessimistic estimate of $150 and an optimistic estimate of $50.

23:36 And therefore our standard deviation being pessimistic minus optimistic over six is $150 minus $50 divide by six, which gives us a standard deviation of $16.66.

23:52 So that means we could say with certainty that we are 68 per cent confident that we will deliver this activity for eighty six dollars and sixty six cents plus or minus sixteen point sixty six cents or if we wanted to go to 95 per cent certainty of delivering this activity or two standard deviations, either side of the mean, we would say we are 95 per cent confident we would deliver this activity for $86.66 Plus or minus $33.32.

24:29 Now you need to know those formulas for the exam, because you may get a question that asks you about the range of certainty and how to express it in terms of standard deviations. So a tip when you start the exam and you're putting down your brain dump on your note paper put down the three point estimating technique formula.

24:50 The standard deviation formula.

24:51 And the variance formula as well.

24:53 And as I've already said, you don't need to remember it in two forms of the T and the little C. Just remember it as the O, the M and the P.

25:02 It's the same formula for both cost and time estimating.

25:07 We've already talked about group decision making techniques and group creativity techniques. There's a big overlap between the two.

25:15 But if we need a group of people to help think about a good cost estimate, these are some of the techniques we could use brainstorming which has given me to think outside the box and a bit creatively about all the possible cost estimate permutations. And then once we have them using the nominal group technique to get them to vote on which of those cost estimate ideas and decisions should be taken forward.

25:40 A technique that I particularly like is the Delphi technique, and this is designed to get around one of those large group scenarios where you've got the loudest person talking whose opinion gets forced on everybody else or you've got introverts or junior staff who who don't feel they can talk in that environment.

25:58 So the Delphi technique is designed to get around that you simply ask these people to be involved in your cost estimating excised but anonymously, they don't know who else is being asked or how many other people are being asked.

26:11 You've seen them information in this case about the cost estimating advice you want. They provide that advice back to you.

26:20 You collate that advice and seen it all the way back out to all the experts without identifying individual respondents and give them time to think about the other information provided they may choose to change their opinion.

26:34 And this way, you get exPERTs having considered opinion without peer pressure or groupthink or bullying.

26:41 And once you have all those cost estimates coming in in terms of making the actual decision, as I've already said, it would be really useful if your cost management plan outlined how the final decision would be made.

26:55 Are you going to use consensus where all the experts must agree on the particular cost estimates? Are you going to use? A majority of over 50 per cent have to agree or a simple majority of the largest voting block wins? Or are you going to allocate the decision to a single decision maker? All of these things should be decided upfront and put into your cost management plan. So.

27:22 Using these tools and techniques on these outputs, these are the possible outputs, we could get individual activity cost estimates.

27:32 So all of our individual activities now have a cost estimate assigned to them.

27:37 Now these cost estimates can change throughout the life of a project at the beginning of the project.

27:43 We may not have that much information about our activity or that activity may not actually be programmed to occur for 12 months.

27:53 And those conditions are cost estimates will be inaccurate, and we need to recognize that we also may want to have a basis of estimates, which is further information about how we arrived at our estimates, the assumptions we've made, the information we had at hand, the information we didn't have at hand.

28:14 All of these are valuable basis of estimates.

28:17 So when we come to reinstate or check the estimates, we know the assumptions we made.

28:24 We may also want to update particular project documents, and these project documents could be a commitment to continuous improvement.

28:34 With our lessons learned, historical information to help future analysis estimates be made or any other aspect of our cost management process that we think should be updated.

28:46 Now, when we come to describing costs, there's some Standard terminology we can use.

28:53 You'll need to know these for the exam, so pay particular attention here. Generally, we've found that the question the exam will either focus on either end of the extreme of this range.

29:05 It will either ask you to know what an order of magnitude estimate is or a control estimate. But if you're giving an estimate of, say, $50 to $200, then that's what we call an order of magnitude estimate minus 50 to plus 100 per cent is the range.

29:26 Is also a rough order of magnitude estimate, a conceptual estimate.

29:32 A preliminary estimate with a range of minus 20 to plus 30 per cent, a definitive estimate with a range of minus 15 to plus 20 per cent and a control estimate with a range of minus 10 to plus 15 per cent.. There's a little sentence there at the top that may help you remember this for the exam and that is controlling definitely beats preliminary concepts by an order of magnitude that may help you remember them for the exam, but do pay particular attention to this.

30:05 We generally expect at least one question the exam to expect you to know how to describe your range of estimates.

30:14 So in summary, the estimate costs process has gone out and used the most appropriate estimating technique to estimate an individual cost for each activity.

30:27 And has also expressed a level of certainty or uncertainty in your cost estimate and perhaps accounted for it with some form of contingency reserve. Thank you.

30:39 This has been an introduction to the estimated cost process in the PMBOK guide.