The disciplines of cost estimating and cost planning are not well understood.
There’s confusion about whether cost estimates and cost plans are the same thing.
And if you’re a project manager or technical expert, you might be uncomfortable coming to terms with the commercial aspects of your profession. That’s understandable — your core competency is managing or designing, not accounting.
But as a project manager or technical expert, you need to be comfortable making cost estimates and developing cost plans. So let’s see if I can help ease your discomfort …
What’s the difference between a cost estimate and a cost plan?
Here are the basic (but not the only) differences between cost estimates and cost plans:
A cost estimate is an assessment or approximation of the likely costs of an initiative with an indication as to the degree of accuracy, usually +/- percent.
In the construction industry — a good example of project management — a cost estimate is a prediction of the costs of construction.
A cost plan determines the fiscal feasibility of an initiative. This is done by setting the lifecycle budgets and cost controls to manage the delivery and quality of the initiative’s outcomes over a set timeframe.
In the construction industry, a cost plan is used as a way of controlling the estimated costs during the design and construction phases of a project.
That means that cost plans are living artefacts, just like project management plans. They must be managed throughout the lifecycle of any initiative in any industry.
The art, or for that matter the science, of where cost estimation migrates into cost planning, relies on sound commercial principles. It requires the right modelling tools and a good dose of experience.
Some guiding principles
The guiding principles to cost estimating and cost planning are:
- Time is money.
- Risk and reward are opposites. The higher the risk, the greater potential for reward. If the risk is unsustainable, there’ll be no reward.
- Appropriate controls to develop, implement and manage cost estimates and cost plans are the key to repeatable quality outcomes and commercial success.
Cost estimating and cost planning outcomes provide the framework for cost control through the lifecycle of any initiative. Cost control is making sure you stay within the budget set during the cost estimating and cost planning processes.
The execution or implementation of guiding principles comes in many forms and permutations. Most project management knowledge has a chapter on cost estimating and cost planning, and the need to control this scarce resource.
Managing cost sits at the top of project management criteria, along with managing scope, time and quality. I could argue that if costs are not managed then it’s likely the other three are not under control either.
So, the capability to develop such financial models is dependent on your commercial intellect and your relevant industry experience.
An experienced cost estimator/cost planner must have a multi-disciplined capability to visualise, over time, the cost of designs, materials, effort, risk etc., and apply commercial strategies to present the plan in a logical and structured manner.
A look at cost estimating
The notion that cost estimates don’t need to be that accurate — since by definition, they predict the future — is a fallacy.
It’s true that cost estimates are a rough order-of-magnitude figure. And, yes, the basis for the estimates is in the assumptions, constraints, limitations, etc.
But in business, we can’t plan for and bid for work without estimates.
The trick is to ensure that the numbers, and the strategies to support the numbers, have substance. The difference between a good estimate and a bad estimate can result in not winning work, or in winning the work but losing money.
Types of cost estimates and tolerances
Here are the most commonly named estimates I’ve come across:
- Ballpark estimates (BPE). These generally have a +/- 50% tolerance. They can range up to 100%.
- High-level estimates (HLE). These have tolerances of +/- 30% up to 50%.
- Detailed estimates (DE). These have the least tolerance with about +/- 10% to 20%.
Obviously, as the level of detail and knowledge of an initiative increases, the level of tolerance required of the estimate decreases.
The cost estimating lifecycle
As I said before, cost estimating (and cost planning) requires sound commercial principles, the right modelling tools and experience.
Here are four elements that will raise your chances of cost estimating success:
1. Subject matter expertise and industry knowledge
To estimate well, you need to have a broad understanding and experience in the products that you’re estimating.
That means you need to know of and understand the industry benchmarks. For example, it helps to know that the industry benchmark for a daily rate is $800 or for a metre of cable is $2.50 + GST.
2. Estimating techniques
You need an understanding of different estimating techniques.
PMBOK® Guide, developed by the Project Management Institute, explains techniques such as: bottom up, top down, and plus or minus tolerances.
Your expertise, knowledge and use of the right technique contributes about 50% to your estimate’s accuracy.
A good Excel workbook, with a number of cross-check traps and macros, can serve you well. There are estimating programs, although they’re more suited to the construction industry.
Using the right tool adds about 30% accuracy to your estimate.
4. Governance and management reviews
These are essential elements that ensure your estimates are checked and cross-checked, meet industry standards and fit business expectations.
Cost reviews contribute 20% to the accuracy of your cost estimate.
A brief look at cost planning
Successful cost planning is made up of diversified choices in approach and execution. There’s no one approach that fits all scenarios. It’s a case of making the best and most appropriate choices to fit the situation.
Before developing the cost plan for any initiative, you need to consider the framework. And there’s a lot to consider — more than can be covered in this article.
Here are some of the decisions that need to be made in order to determine the best approach for your cost plan and deliver the desired outcome and accuracy:
- What is being planned? IT? Construction? Something else?
The principles are the same but the environment, approach and tolerances will be different.
- Should I amortise costs, or do I declare a contingency to cover risk?
- Is the opportunity a deal or a contract?
A contract may have penalties for non-performance or delays. A deal is more of a partnership. There are obvious cost implications for both.
- Do I need to test the market with an RFI or RFP/RFT/RFQ?
- What is the commercial envelope? Is it fixed lump sum, target sum, open book, or other?
- Has there been a sound assessment of the risk versus the complexity?
- What is the degree of confidence and/or accuracy?
- Do I need to obtain market coverage to sharpen the accuracy?
- Is there a comprehensive work breakdown structure (WBS) for services and materials?
- Do I have a strong understanding of the concept of money and the methods to determine the investment value or the return on investment? What about developing present and future value-of-money models using discount cash flow (NPV/IRR)?
- Have the business investment rules been factored into the planning framework? Things such as the hurdle rate, CPI, tax rate?
- How does time affect the proposed cost plan?
- Is risk covered and are there adequate contingencies?
As I said, there’s a lot to consider. But effective cost planning depends on your decisions regarding these matters.
It’s not an insurmountable task
The success formula for repeatable execution of quality cost estimates and cost plans is a combination of experience, commercial intellect, and choices of optimal tools and approach.
Cost estimating and cost planning are both an art and a science.
But, most importantly, they require a strong dose of structure and discipline.
And never underestimate what experience brings to the table!