What are the 3 main methods of cost estimating?
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Projects and other undertakings require cost estimation to determine resource requirements. Of course, estimates are not definite and their accuracy depends on the project stage in which they are undertaken and the sources of data. Nonetheless, there are three types of cost estimation classified according to their scope and accuracy. These are (1) order of magnitude estimate; (2) budget estimate; and (3) definitive estimate. 1. Order of magnitude estimate: An order of magnitude estimate is a rough estimation of costs used at the very early stage of a project, particularly during the evaluation and planning stages. The purpose of this type of cost estimation is to have an idea about general and total expenditures instead of itemizing expenses based on project activities and deliverables. Managers and planners can us historical
data of a related project or an aggregate of data from different projects to perform an order of magnitude estimation. There are situations when no data is used at all. The accuracy is around -50 percent to +100 percent of the actual cost. Figures generated from this method of estimation are sometimes called ballpark figures. 2. Budget estimate: Also referred to as preliminary cost estimates, budget estimate is more accurate than an order of magnitude estimate. Accuracy is
around -10 percent to +25 percent. The purpose of this type of estimation is to generate a preliminary itemized list of expenditures based on the major components of the project. Therefore, this is done within the actual planning stage of the project. There are specific types of cost estimation under budget estimate. One example is top-down estimate in which costs of the major components of the project are estimated using historical data of a related project or obtainable data using the
project plan. Another example is an estimation of expected labor cost or a summative costing of equipment and materials requirements. 3. Definitive estimate: A definitive estimate has an accuracy of around -10 percent to +15 percent and in some standards, around -5 percent to +15 percent. Sometimes called as detail cost estimates, this type of cost estimation are not only more accurate than order of magnitude of estimate and budget estimate but are also more detailed. Reports generate from a definitive estimation include an extensive itemized list of project activities and deliverables with brief descriptions either for justifications and clarity. However, note that conducting a definitive estimation is only possible with a fully developed project plan and a work breakdown structure It is important to reiterate the fact that the accuracy of cost estimation depends on the availability of
data, as well as the project stage in which it is particularly conducted. Take note that as the project plan becomes more developed, more data can be generated and thus, budget estimates or detailed estimates become more possible. Nonetheless, regardless of the methodology used, cost estimation is a standard process observed in project management all the way down to portfolio
management. It helps identifying resource requirements and capabilities, setting priorities, and allocating resources for project planning and controlling. Costing and valuation are often the immediate byproducts of cost estimation and a review of generated reports can help guide decision-makers. Estimating cost is an important process in project management as it is the basis for determining and controlling the project budget. Costs
are estimated for the first time at the beginning of a project or even before a project has started. Subsequently, the (re-)estimation of the project cost is repeated on an ongoing basis to account for more detailed information or changes to the scope or timeline. For instance, if the
earned value management measures that are used for controlling project cost indicate significant variances from the budget, a re-estimation of the cost and schedule and a revisiting of the overall budget can be inevitable. The methods introduced in this article are tools and techniques of the “Estimate Costs”
process that is part of PMI’s Knowledge Area “Project Cost Management” (see PMBOK®, 6th edition, ch. 7.2). A Cost estimate is a quantified expectation of how many resources are required to complete a project or parts of a project. Such cost estimates are often expressed in currency units. However, other units such as man-days can also be used if the currency amounts are not applicable or irrelevant. There are different types of cost estimates. The Project Management Body of Knowledge lists the rough order of magnitude (ROM)
and the definitive estimate. Both types differ in respect of their accuracy, the project phases in which they are used as well as the available tools and techniques. Some projects use additional, sometimes industry-specific types of estimates. Cost estimating involves different tools and techniques which typically include
Read on to learn the details of these techniques, supplemented with examples and practical considerations. What Are the Types of Cost Estimates?According to the PMBOK®, there are 2 types of cost estimates:
Some sources also list so-called preliminary estimates and budget estimates as further gradations of estimate types. There are also industry-specific types of estimates such as design and bid estimates in construction projects (source). However, the current PMI project management framework only refers to the 2 above-mentioned types. If the budget has to be revisited part way through a project, a so-called estimate to complete (ETC) is determined. Rough Order of Magnitude vs. Definitive EstimateThe obvious difference between these 2 types of estimates is the accuracy: the ROM is rather inaccurate with a broad range of possible outcomes. It is therefore typically used in project initiation phases where a ballpark figure is sufficient to get a project started. The definitive estimate is determined in the course of the project when more information and resources for accurate estimates are available. Read this article for more details on the ROM and the differences between ROM and definitive estimate. Estimate to Complete (ETC) and Estimate at Completion (EAC)If partway in a project it turns out that the budget baseline (based on previous estimates) cannot be met, a re-estimation of the project cost is required. This is done by determining an estimate to complete (ETC) which is used to calculate a new estimate at completion (EAC) that replaces the initial budget at completion and thus becomes the new cost baseline of a project. When Are Cost Estimated?Costs are estimated at different points in time throughout the project. The PMBOK states that the process is performed “periodically throughout the project as needed” (source: PMBOK®, 6th edition, ch. 7.2). The first point to estimate cost is during the initiation phase, e.g. when the project business case or the project charter is created. For these documents, a project manager has to determine the amount of resources that is required to complete the project. As the information that is available at that point is usually not very detailed, the project manager will likely end up producing a rough order of magnitude estimate rather than a definitive estimate. Later in the project when more information is available, this order of magnitude estimate will be replaced with a definitive estimate. After the project initiation phase, the cost will be re-assessed during the planning phase, using the techniques introduced in this article. In subsequent phases, costs are typically (re-)estimated if relevant new information and details become known or if changes to the project scope or timeline occur. One of the common reasons for re-estimating cost is, for instance, when the indicators of the project controlling suggest that the original budget baseline cannot be met. Why Is Cost Estimation Important in Project Management?Estimating costs is one of the core activities of project management and planning. This is because a project is defined as being subject to at least three fundamental constraints: scope, budget and time. Cost estimates are obviously addressing the budget constraint; hence they are highly relevant for the management of a project. The initial rough cost estimate is usually included in the project charter as well as in the business case of a project. The estimation of costs is also necessary to compute the project budget which is subject to the approval of the project sponsor(s). In fact, the process “determine budget” uses a technique called “cost aggregation” which directly refers to the outputs of the “estimate cost” process. Cost estimates are the basis for allocating budget to work packages and deliverables which can be politically sensitive within a project as well as among its stakeholders. Therefore, budget determination and assignment require some stakeholder involvement, communication and, in many cases, their approval. In addition, cost estimates are input parameters for the earned value and variance analyses as well as forecasting of project costs. This section provides an overview of the tools and techniques for estimating project costs. These methods refer to chapter 7.2.2 of PMI’s Project Management Body of Knowledge. Click on the links to the detailed articles on these techniques to find further explanations and practical examples. Comparison of Estimation TechniquesThis table compares the approaches to estimating project costs and highlights the differences between these techniques.
Expert JudgmentThis technique is suggested by the PMBOK (ch. 4.1.2.1) as a way to produce a cost estimate. If you or your team have experience with the kind of work that is in the scope of a project, you can use expert judgment to produce an estimate. This requires a certain level of familiarity with the subject of a project and its environments such as the industry and the organization. Expert judgment can be applied to both bottom-up and top-down estimating. Its accuracy depends greatly on the number and experience of the experts involved, the clarity of the planned activities and steps as well as the type of the project. Two examples of expert judgment are:
Besides being an estimation technique on its own, expert judgment is also inherent to the other estimation techniques. For instance, if the comparability of previous work and the current project is assessed or adjustments to parametric estimates are determined. Analogous estimatingAnalogous estimating refers to the use of observed cost figures and related values in previous projects (or portions of a project). In order to be accurate, the type and nature of these reference activities must be comparable with the current project.
This technique uses historical data in the form of values and parameters to determine the expected resource requirements of a current project. The historic values are adopted for the current work and can be adjusted for differences in scope or complexity. Analogous estimating is categorized as a gross value estimating approach. In general, analogous estimates are used if a project has access to historical data on similar types of work while the details and resources for more accurate estimates in the current project, such as parametric or bottom-up estimating, are not available. Parametric estimatingParametric estimating is a statistical approach to determine the expected resource requirements. It is based on the assumed or proven relationship of parameters and values. Simple examples are the building cost per square foot in construction projects or the implementation cost per data field in IT projects. If, for instance, the cost of implementing a new data field in an IT system were $20,000 according to historical data, and a project required 15 new data fields, the total cost of this part of the project would be 15 x $20,000 = $300,000. The input data can be obtained from previous projects or external data sources such as industry benchmarks or publicly available statistics. In practice, this technique is employed with a broad variety of sophistication and accuracy. It can be used with a simple ‘rule of three’ calculation but also in conjunction with a complex statistical or algorithmic model that may consider multiple quantitative and qualitative parameters for detailed regression analyses. In projects that do not use an explicit statistical correlation analysis, some expert judgment is required to assess whether it would be reasonable to apply the historic parameters to the current project. Complexities of projects and activities vary and may therefore require certain adjustments. For instance, building a highway in a mountainous region likely produces a higher cost per mile than in a flat area. IT development projects in complex IT architectures or systems tend to require more resources than a less complex environment. Another consideration concerns the expertise and experience of the project team. If a previous project was delivered by highly skilled and experienced resources while the current team is just at the beginning of its learning curve, using unadjusted historic data may understate the estimated cost. Similar to analogous estimates, adjustments can be made to adapt the parametric estimates to the current project. Depending on the quality of the input data and its applicability to the current type of work, the parametric estimation technique can produce very accurate figures. However, the higher the accuracy desired the more resources are needed to perform the data gathering and statistical analyses. Bottom-up estimatingBottom-up estimation refers to a technique that involves estimating the cost at a granular level of work units. The estimates for all components of a project are then aggregated in order to determine the overall project cost estimate. In practice, these estimates are often performed at the lowest level of the work breakdown structure (WBS), e.g. for work packages or even activities. While there is no clear rule on who should be performing this estimation, it seems to be a good practice in project management: asking those project team members who are operationally in charge of the respective work packages or activities to estimate there on work. Thus, this approach to estimating costs often comes with significantly higher accuracy than top-down estimations. However, obtaining and aggregating these granular estimates normally requires some resources and can potentially become a political challenge, especially in large or complex projects. Three-point estimatingThree-point estimating is a technique that usually leverages on bottom-up estimates, analogous or expert estimates. The concept requires three different points of estimates: the optimistic (best case), pessimistic (worst case) and the most likely cost estimate. Based on these 3 points, a weighted average cost estimate is determined that overweighs the “most likely” point. This can be done by assuming a triangular distribution, a PERT or beta distribution. Read this article for further explanation and examples of this technique. ConclusionIn this article, we have discussed the techniques of cost estimating as suggested by the PMBOK. Note that the level of detail and granularity of the estimates usually increases throughout the project. In the initiation phase, the rough order of magnitude (ROM) is often the only type of estimate that can be obtained. Definitive estimates will usually require techniques such as analogous, bottom-up and parametric estimating that may only become available in later stages of a project. Parametric and bottom-up estimates are usually the techniques that provide the most accurate cost projections. They are commonly used if the budget needs to be revisited and replaced with a new estimate at completion. When a budget is determined and approved, earned value analysis and variance analysis help project managers control the cost and value generated in a project. You will find more details on the measures and the techniques in this article. What are 3 types of cost estimates?The three types of cost estimates are design, bid, and control estimates. Design estimates are prepared in the project preliminaries which gives the order of magnitude of the project cost.
What are the three main components of a cost estimate?In spite of the many types of cost estimates used at different stages of a project, cost estimates can best be classified into three major categories according to their functions. A construction cost estimate serves one of the three basic functions: design, bid and control.
What are the cost estimation methods?The four major analytical methods or cost estimation techniques used to develop cost estimates for acquisition programs are Analogy, Parametric (Statistical), Engineering (Bottoms Up), and Actual Costs.
What is 3 point estimation technique?Three-point estimating is a management technique to determine the probable outcomes of future events based on available information. The term refers to the three-points it measures: the best-case estimate, the most likely estimate, and the worst-case estimate.
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