What is the most accurate method for developing project cost estimates?

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Estimating the project cost can be a scaring exercise for many managers. It is often seen that many project managers across the industries burn the midnight oil to prepare a perfect estimation. Despite all the efforts, when the project cost exceeds the estimated budget, they face a lot of flak from all the corners. Though a perfect and accurate estimation of project cost may sound like climbing onto the peak of Himalayas, but a near perfect, appropriate estimation can be done with the help of few proper tools and techniques.

There are a lot of uncertainties associated with the project in terms of schedule, scope, and resources. You do not have the clear picture at the beginning; the story unfolds in the later stages. So, it is important to access the future activities of your project at the initial phases considering the available information.

Let us discuss the top 10 tools and techniques which are popular and are used for estimation –

Expert Judgement

While estimating the project cost, the first step is to take the comments from the experts. The experts are the people who have prior knowledge on similar kind of projects. So they can suggest valuable insight based on their experience. You can also take their advice on various tools and techniques that can be used to estimate similar kind of project.

Analogous Estimation

Normally, at the early stages of your project, you do not have much detail, so taking into account of similar projects previously completed by your organization, the cost of the project can be estimated. Analogous estimation technique uses the parameters such as scope, budget, duration, size, weight and complexity of previous projects having similar nature of works. It measures the current project on that basis and does the estimation.

The technique is less costly and less time-consuming. But the accuracy of this estimation is lower than the other estimation techniques as it is purely based on historical data. It can be applied to the whole project or some part of the project in combination with other techniques.

For example, if the budget of a particular activity in the previous project has X amount, and by measuring the same activity in your current project looks identical, then the same X amount can be applied to that.

Parametric Estimation

This technique uses an algorithm to calculate the cost of the activity considering the historical data and other project variables. A statistical relationship needs to be evaluated between the historical data and other variables. This technique can be used for the complete project or for some

of the activities in conjunction with other estimation techniques. This is one of the most accurate techniques to estimate the cost of the project.

For example, in an industrial project, one of the activities is to make 10 valves in the first phase. So as part of historical data gathering, you got the information that construction of each valve requires $150.

Based on that information you can calculate as:

• Total cost of making 10 valves = cost per valves * no. of valves
• Total cost = $150 *10= $1500

Bottom-Up Estimation

Bottom-up estimation technique starts with the estimation from the lower level i.e. the work package level created as per WBS and then rolled up to higher-level. The accuracy of this estimation technique is high as you are doing the estimation from granular level

Three-Point Estimation

To deal with uncertainties and risk, you need to take the help of three-point estimation which is also referred as PERT- Program Evaluation and Review Technique.

The Program Evaluation and Review Technique use three types of estimations:

• M – Most Likely: The realistic or ideal situation, all the required resources will be assigned and can achieve the expected productivity
• O – Optimistic: Estimation based on best case scenario
• P – Pessimistic: Estimation based on worst case scenario

Based on the above assumptions, the expected duration can be calculated using two basic formulas.

• Triangular Distribution – (O+M+P)/3
• Beta distribution – (O+4M+P)/6

Reserve Analysis

To deal with uncertainty, you need to allocate some funds called as the contingency reserve. That is the part of the cost baseline to mitigate the identified and accepted risks. Also for unknown risks, an amount needs to be estimated which is called management reserve. This is not included in the cost baseline but part of the overall project budget. It is important to keep the reserve budget to deal with uncertain events. The contingency reserve is under the project manager authority, while to use the management reserve the project manager need to take approval from the sponsors.

Cost of Quality

Basically, two types of costs are there to ensure the quality, one is called the cost of conformance which is the budget required for prevention and appraisals, and another one is cost of non-conformance that may be used up due to internal and external failures. Cost of quality means estimating the cost of both conformance and non-conformance expenses.

Project Management Software

There are some tools which can be used to perform the project cost estimation, such as cost estimating software application, spreadsheets, simulation and statistical tools.

Vendor Analysis

This is another technique to estimate the cost by comparing the various bids proposed by the vendors. There may be differences in their bids but you can get an idea considering the average bid values.

Group Decision Making Techniques

This technique emphasizes the involvement of a group of people who are going to perform the technical work. By involving those you will gain more details on the work and thus helpful to estimate more accurately. Also, it develops a commitment from the people who are involved in the discussion to complete the work as estimated.

Depending upon the nature of your project, either you can apply these techniques together or in combinations of few techniques to estimate the project cost. Also, keep in mind that the estimations are never drawn to an exact figure; it is always in the probable ranges. In the initial phases, the preliminary estimate ranges between -15% to +50%, while the rough order of magnitude estimates in between -25% to +75%. And the budget estimate falls in -10% to +25% ranges.

Updated on 22-Apr-2022 11:14:23

When facing a new project it is important to choose the correct estimating technique. There are several estimating techniques but the effectiveness of each of them depends on the type of project and in which phase the project is in. In this article we will discuss what the best options for each case are, but let’s first look at some basic definitions.

What is estimating?

Estimating is determining in advance the expected costs of labor, material, construction equipment and tools which are needed to complete a project. The first thing to do in order to create an estimate is to create an estimating plan, which should include:

• Scope definition of the project, defining the boundaries.
• Time plan

Project Life Cycle

The life cycle of a project consists of following phases:

• Identification
• Definition
• Execution
• Operation
• Abandoning

The phase in which your project is will be decisive information to choose the right estimating technique.

Accuracy of an estimate

Every estimate is a prediction of the expected final cost of a project for a given scope of work. Every estimate is associated with uncertainty, and therefore is also associated with a probability of overrunning or underrunning the predicted cost. The estimate accuracy is an indication of the degree to which the final actual cost outcome for a given project varies from its estimated cost. 

It is important to understand that an estimate should never be regarded as a single point number (or cost) but as a range of potential cost outcomes and associated probabilities of occurrence. 

Once we know the scope of our project, the current phase of our project and the accuracy that we expect our estimate to have, we can decided on which estimating technique best fits the situation.

The most important estimate methodologies are factor estimating, parametric estimating and detailed estimating:

Factor estimating

Factor estimating, also known as top-down estimating, is based on limited project scope. It is generally used in the identification phase. It uses rules of thumb, parametric models or historical databases to provide relevant cost data. 

Parametric estimating

Parametric estimating entails the analysis of costs and identification of cost drivers to develop cost models. The approach essentially correlates cost and manpower information with parameters describing the item to be costed. This process is used in the earlier phases of a project (identification and definition) when there is not much specific information about the project, but there is historical data from previous similar projects. 

Detail Estimating

Detail Estimating, also called bottom-up estimating, is used when the maturity level of project definition is high (execution and operational phase). Detailed estimates are made at relatively low levels in the work breakdown structure, typically at work package or task level. This approach is closely related to scheduling, planning and resource allocation and is both time-consuming and costly. It requires a good knowledge of the activity and also needs to have a reasonable level of definition. It also results in the most accurate estimates.

As an example of relations between level of project definition, expected accuracy of estimate and methodology used you can see the figure with the AACE Cost Estimate Classification System.

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