COST ESTIMATION

BT6703 Creativity, Innovation and New

Product Development

UNIT 5 MODEL PREPARATION AND

EVALUATION
 Outline
• Introduction to Cost Estimating
• Data Collection
• Cost Estimating Methodologies
• Cross-checks and Validation
• Risk and Sensitivity Analysis
• Documentation Requirements
• Cost Estimating Challenges
 Introduction to Cost Estimating
• The National Estimating Society has defined Cost Estimating1as:
– The art of approximating the probable cost of something based on information available
at the time.
• Cost estimating cannot:
– Be applied with cookbook precision, but must be tailored to a particular system,
– Substitute for sound judgment, management, or control,
– Produce results that are better than input data, or
– Make the final decisions.
• Despite these limitations, cost estimating is a powerful tool because it:
– Leads to a better understanding of the problem,
– Improves management insight into resource allocation problems, and
– Provides an objective baseline to measure progress.
• The reliability of cost estimates varies over time.
– The closer you get to the actual completion of a project, the estimate
becomes more accurate.
• Four types of cost estimates represent various levels of reliability .
– Conceptual Estimate: Rough order of magnitude or back of the
envelope.
• Often inaccurate because there are too many unknowns.
– Preliminary Estimate: Used to develop initial budget, more precise.
– Detailed Estimate: Serves as a basis for daily project control.
– Definitive Estimate: Accuracy should be within 10% of final cost.
• Important to repeat estimating process (i.e., re-estimate) on a regular
basis as more information becomes available
– This will keep estimate current as well as increase the accuracy
• All cost estimates are constructed by the following tasks:
– Identifying the purpose and scope of the new system.
• New software development, software reuse, COTS integration, etc.
– Choosing an estimate type.
• Conceptual, preliminary, detailed, or definitive type estimate
– Identifying system performance and/or technical goals.
– Laying out a program schedule.
– Selecting a cost element structure (CES).
– Collecting, evaluating, and verifying data.
– Choosing, applying, cross-checking estimating methods to develop the
cost estimate.
– Performing risk and sensitivity analysis
– Time-phasing the cost estimate by fiscal year for cash flow purposes.
• Example: 4 years to develop and 10 years operations and support
beginning in FY2003
– Providing full documentation.
 DATA COLLECTION
• Two types of data sources:
– Primary & Secondary
– Primary data is found at the original source (e.g.,
contractor reports, actual program data, etc.)
• Preferred source of data
– Secondary data is derived from primary data of
another similar system such as documented cost
estimates, cost studies/research, proposal data, etc.
• Second choice to primary data due to data gaps
• May be best alternative when time constraints or data
availability limit primary data collection
• Forward Pricing Rate Agreements (FPRA)
• Similar program historical actual costs and
estimate documentation
• Engineering drawings/specifications,
• Interviews with technical and program
management personnel
• Surveys
• Professional journals and publications
• Industry guides and standards
• Technical Manuals
 Cost Estimating Methodologies
• Once data has been collected and normalized
to constant dollars, there are five
methodologies available for estimating costs:
– Expert Opinion,
– Analogy,
– Parametric,
– Engineering, and
– Actual.
 Estimating Methodology Consideration
• Choice of methodology is dependent upon
– Type of system
• Software, hardware, etc
– Phase of program
• Development, Production, Support
– Available data
• Historical data points from earlier system versions or
similar system
• Technical parameters of system
 Cross-checks and Validation
• After an estimate has been created, the next step involves validating the
estimate by cross-checking.
– Cross-checking means using a different approach to create the
estimate.
– If both estimates are close, the target estimate has some validity.
– If both estimates are very different.
• This increases the level of uncertainty which must be reflected in a
risk analysis.
• This may lead to another estimating method to increase cost
estimate confidence.
• It is a good practice to cross-check major cost drivers.
– If time is available, cross-checking other cost elements can further
validate the entire estimate.
• Factors tend to be the most common approach for top level checks.
• Software cost models play an important role during later stages of
development phase.
– Can be used to cross-check the reasonableness of costs forecasted
using either the engineering or actual cost methods.
Validation also includes a demonstration that:
– Model users have sufficient experience and
training,
– Calibration processes are thoroughly documented,
– Formal estimating policies and procedures are
established, and
– When applicable, information system controls are
maintained to ensure the integrity of the models
being used.
 Risk and Sensitivity Analysis
• Risk analysis is a process that uses qualitative and quantitative
techniques for analyzing, quantifying and reducing uncertainty
associated with cost goals.
• By nature, all cost estimates have some uncertainty.
– Earlier in development that uncertainty is higher.
– As the project matures these uncertainties decrease due to
greater design definition, actual experience, and less
opportunity for change.
• Errors can also occur from historical data inconsistencies.
• Cost risk analysis aims to achieve the following objectives:
– Identify program level confidence for development
schedule,
– Provide credibility to the target estimate, and
– Identify technical, schedule, and cost estimating risk drivers
for use in risk management.
• Risk is defined as a situation in which the outcome
is subject to an uncontrollable random event
stemming from a known probability distribution.
– Roll of two dice is an example since the roll can result
in one of 11 possible outcomes.
• Uncertainty is defined as a situation in which the
outcome is subject to an uncontrollable random
event stemming from an unknown probability
distribution.
– Example would be will it rain two weeks from today?
• Cost estimating falls more into the range of
uncertainty than risk, but most managers use the
term risk analysis.
 Sources of Cost Risks
• Schedule and Technical risks
– Unexpected design changes
– Project team experience
– Number of business units impacted
– Requirements changes
– Integration considerations
– Technical difficulties or maturity issues
– Revised project or acquisition plans
– Quantity changes
– New labor rates
– Higher inflation
• Cost estimating risks
– Imprecision associated with the estimating techniques
used, errors, or oversights
 Documentation
• After cross-checking the estimate major cost drivers, the next
step, and most important one of all, involves documenting the
entire estimate process.
• Although this is a difficult and time-consuming procedure, the
level of detail and attention will pay big dividends when it
comes time to re-estimate
– May also help data collection of actual analogous costs.
• Important to document the estimate as it is being developed
(i.e., document as you go).
– Hard to remember rationale and judgments for adjusting
data months later when it needs to be documented.
– Documenting as you prepare the estimate leads to a better
quality estimate and requires minimum effort at the end
 Cost Estimating Challenges
• Access to historical data
– Need to invest in database capture of historical costs and technical data for
proper CER development
• Costly, time consuming, and usually not funded
• Development costs for IT systems can quickly become outdated by new
programming languages
• Maintenance costs are even more difficult to capture because they are
seen as on-going support or overhead and not as metrics
• System architecture change effects on cost estimates can be hard to
determine
• Validity and uncertainty of data
– Garbage in = Garbage out
• Limited time to develop estimates
– Can result in rough-order magnitude costs being used as budget quality
estimates
– Cause important steps like validation and Monte Carlo simulation to be
omitted
• Resources
– Lack of trained people is a problem