Don't Add Risk And Double Investment Requirements By Estimating Project Budgets Incorrectly

Don’t Add Risk And Double
Investment Requirements By
Estimating Project Budgets
Incorrectly
Ed Kozak

contractor that we’re subbing to uses this
After 13 years of budgeting and same formula and if it’s good enough for
them it’s good enough for us.” The
managing projects I went to work for an
IT firm during the heyday of the Internet formula itself assigned what appeared to
Bubble. My new firm was hired as a be an arbitrary cost to each of the
recommended third-party by the different types of statuses of people one
contractor to consolidate and reduce the might find in a pension database. For
errors in pension databases before being example, one who still works for the
loaded onto the contractor’s site for call company is an ACTIVE and each person
center management. I was astounded to in this category was assigned a specific
see that there was no cost accounting cost per head, for the sake of argument,
system in place with which I would be let’s say 40 cents. Employees who no
able to track costs. “We’re the only one longer worked for the company were
in our niche” said the company President labeled TERM for terminated and were
“Trust me, we make more than enough further broken down into Vested Terms
money.” (VT) and Non-Vested Terms (NVT).
VTs were assigned a second cost per
I was further astounded when it came head, say 35 cents, while those labeled
time to work on my first proposal for as NVT were assigned a third cost per
them. Instead of estimating how much head, say 20 cents. Two other categories
the work would cost by figuring out the that were sought out were Retirees, RET,
required number of labor hours needed and those listed in the system who were
to perform the job and multiplying that now deceased, DEC. Employees labeled
number times labor rates and overhead RET were assigned a fourth cost
multiples, I was given a parametric category, 30 cents per head, while those
formula to use—something that based who fell into the category DEC fell into
the cost of the project not on our labor the fifth category and were assigned a
hours but on some variables found in the cost of 15 cents per head. Prior to
database that we were to cleanse. When submitting a proposal to a client we
I questioned whether this was the needed to receive the most recent
optimal estimating technique to use the electronic copy of table of their pension
Senior VP replied to me “It’s obvious database that contained all of the
you don’t know our industry. The employees and their respective statuses

so that we could correctly count the test it, fix the errors, and then test the
number of people that fell into each fixes. We had to incorporate business
category. The cost of the work that rules into our code as well. Many of our
would be proposed to the customer clients were large corporations that had
would then be calculated as grown by acquiring other firms and so
one client could have 12 different
# Active Employees x .40/ Active pension plans in place, each representing
persons a division of that company that was an
#Vested Terms x .35/VT persons independent company in its own right
#Non-Vested Terms x .20/NVT persons that had gotten acquired. To add to the
#Retirees x .30/RET persons complexity, employees could possibly
+ #Deceased x .15/DEC persons. work for more than one division during
the course of his or her employment and
As mentioned earlier, this estimating so would have different rules applying
method was based on the model that the for benefit accruals. The bottom line is
prime contractor used. However, it was that this was intense work requiring
used by the prime to calculate the costs 24,000 person-hours worth of work over
expected per year to cover the volume of an 18-month period and the cost of
calls to their call center and was based which couldn’t be extrapolated using a
on the prime’s historical information. formula to calculate the anticipated
That is, during a given year they workload for a call center. For this type
expected to get a certain number of calls of work a different choice of estimating
from Active employees with questions method should have been used, but
and concerns about their pensions, which one?
slightly less from Vested Terms and
slightly less from Retirees who were
already collecting a pension (Obviously, The Four Basic Estimating Methods
deceased employees and Non-Vested
Terms still had to have data processed Four basic estimating methods are
even though there wouldn’t be any calls available to project managers—
from them, so they were charged a Apportioned Estimating, Parametric
nominal rate). By keeping track of the Estimating, Bottom-Up Estimating, and
number of calls, the type of employee Expert Opinion. Each has its strengths
making the call, and the amount of time and weaknesses and each introduces its
required to service each call across all of own inherent risk into a project. The
its clients, the contractor was able to use key to using any of them is to understand
it to calculate an effective yearly service what type of work it’s best suited for and
fee to charge its clients and to estimate to understand its limitations.
costs for new ones.
Expert Opinion is nothing more than
The thing that the Management of my what it sounds like—an educated guess
company didn’t realize was that our about how much a task or a project will
work was completely different. We cost made by a subject-matter expert.
weren’t managing a call center. We On the positive side, it’s simple,
were writing computer code to extract straightforward, and takes little time to
data from numerous tables, compare it, produce. Little or no historical data is
Estimating Project Budgets – Which Method Should You Use? 2
©Successful Projects For Leaders. No portion of this document may be copied or distributed without the expressed
written consent of the author.

required to make this estimate and it’s other. Take for example, a cement
very suitable, in fact, probably the most contractor that is in the business of
suitable, for cutting edge projects that pouring driveways for its customers.
have never been done before. On the Each driveway requires the grading of
negative side, the estimate itself can be the land, the delivery of the sub base,
off by a margin of 100%, by its very wooden framing material, placement of
nature it’s very subjective, being based the reinforcing material, the pouring of
on opinion, and can suffer from the concrete, the finishing, and the
something known as estimating bias, that removal of the framing material. As the
is, preference toward a particular result size of the desired driveway increases so
influenced by the estimator. The best does the added material, the additional
way to minimize estimating bias, by the concrete, and the additional labor
way, is to have a pool of experts required to pour and finish. Assuming
independently come up with their own the cost of the lumber to frame the
estimates and, if there are large driveway out is minor compared to the
discrepancies, have the group resolve the time required to frame the driveway,
differences. If discrepancies are small pour the concrete, finish the concrete,
an average of the estimates can be taken. and the cost of the concrete itself, we
can find a way of relating the cost for a
Parametric Estimating has already driveway to the number of cubic yards
been discussed in the example but a of concrete needed for the driveway.
formal explanation is given here as well. What would be needed would be to keep
A parametric estimate is one where the historical information showing the
cost estimate is not based on labor amount of concrete used along with the
dollars but on some other variable that total labor time required to frame, pour,
itself is based on labor dollars. It is and finish. Let’s say that contractor
assumed that the labor and that other recorded the data from his past 10 clients
variable are linearly related to each as follows:

Driveway Dimension Concrete Labor Time
2 3
Client Area (ft ) (yds ) Framing Finishing Total
1 750 15’ x 50’ 9.26 2.86 hrs 7.5 hrs 10.36 hrs
2 525 15’ x 35’ 6.48 2.2 hrs 5.25 hrs 7.45 hrs
3 315 9’ x 35’ 3.89 1.94 hrs 3.15 hrs 5.09 hrs
4 280 8’ x 35’ 3.46 1.89 hrs 2.8 hrs 4.7 hrs
5 450 9’ x 50’ 5.56 2.6 hrs 4.5 hrs 7.1 hrs
6 400 8’ x 50’ 4.94 2.55 hrs 4 hrs 6.55 hrs
7 900 18’ x 50’ 11.11 3 hrs 9 hrs 12 hrs
8 630 18’ x 35’ 7.78 2.33 hrs 6.3 hrs 8.63 hrs
9 810 18’ x 45’ 10 2.77 hrs 8.1 hrs 10.87 hrs
10 675 15’ x 45’ 8.33 2.64 hrs 6.75 hrs 9.39 hrs

By dividing the amount of concrete used square foot of driveway roughly requires
by the total hours in each case we can .015 clock hours of time. Assuming the
see in this simplified example that one contractor uses a four-person crew, after

factoring in the labor rate, profit, and software package to perform a linear
any other overhead rates let’s assume the regression that will fit the data to the
contractor bills $240/hour for this work. function of a line and identify which
At .015 clock hours of time, one square variables are the strongest to use to
foot of driveway costs $3.60 of labor account for the cost. Another negative is
time. After the contractor has gone the uncertainty in the parametric
through this calculation one time he can estimate. While the uncertainty isn’t as
use the information to make future bad as that of expert opinion, it can have
estimates based solely on the number of a margin of error of 75% if not enough
square feet of driveway: historical information is used or if the
estimate is applied incorrectly.
Cost = Number of Sq. Ft of driveway
times $3.60/Sq. Ft. + Material Costs Apportioned Estimating, otherwise
known as Top-Down Estimating,
Material Costs: Concrete: #Sq. Ft. of Analogy Estimating, or the Analogy
driveway times .012348 Cubic Yards Method, assumes that the work to be
Concrete needed per Sq. Ft of driveway done is very similar to work that has
@ $75 Cubic. Yard + Reinforcement @ been done in the past. What separates
$.10/Sq. Ft. of driveway. apportioned estimating apart from
parametric estimating is that quite often
As one can see, a major positive for this only one prior sample is used instead of
is that once the formula is created it many. The prior experience is compared
takes no time whatsoever to use. It can to the new proposed project and
easily be changed to reflect new labor adjustments of price are made to factor
rates, new overhead rates, and/or new in changes in scale, complexity, or other
concrete costs. A drawback for this differences. In other words the starting
model is the fact that it is not robust, that point for the analogy estimate is the
is, if the model has been used to statement “We’ve done something
calculate the cost of driveways then one similar to this before only that that one
can’t assume without testing that it’s was (smaller/larger, more complex/less
applicable to pavements, patios, garage complex, etc.” An adjustment factor is
slabs, etc. Another drawback is that real then used to scale up or down the total
data doesn’t fit cleanly into a formula as cost incurred for the prior experience.
it is shown in this example. There is Once the top level (i.e. total) cost of the
always variability and the only way to work is known, the budgets for the
ensure that you’ve averaged out all of individual tasks can be assigned, or
that variability is to take plenty of data. apportioned, from the overall estimate
Ten prior examples certainly aren’t by comparing ratios from the prior
enough. It might require twenty-five or experience. For example, if Task A in
even fifty. Can we be assured that all the prior job required 10% of the budget
relationships are linear in nature? The then Task A for the new project also gets
answer is no. Have we factored in all of 10%, if Task B of the prior job required
the variables that we need to? The 25%, it is assumed that Task B for the
answer is that it depends on what we’re new project will require 25%, and so on.
trying to model. The best way to The positives for apportioned estimating
proceed would be to use a statistical include its speed of use and the fact that

it is based on the costs incurred of actual use it inappropriately to estimate
previous work. The biggest drawback projects as in the example provided
for this method centers on the use of gives it a higher margin of error than for
historical data to make estimates for apportioned estimating which has a
future work. The older the data is the margin of error of 25%.
more incorrect it can be. Labor rates
escalate, material prices fluctuate, Bottom-Up Estimating or the Cost
industry practices change, Government Engineering Method is by far the most
regulations can be relaxed or be put into time consuming but most accurate
effect, reducing or adding costs, and estimating method of the four. The
technological advances can change the starting point for bottom-up estimating is
nature of the way work is conducted. the WBS or Work Breakdown Structure.
In short, the WBS is the roadmap for the
A great analogy for the use of project. It lists out all of the tasks that
apportioned estimating is the budgeting need to be performed in order to get
for a wedding reception. No matter what from A to Z as well as their subtasks and
one’s budget is, a wedding reception can their subtasks’ subtasks. The starting
still be planned. From a limited male’s point for this estimating method is the
perspective, the major categories of the smallest level task. The following
reception can be broken down into: A. painstaking but necessary steps are used
Location for the reception (includes food in order to properly create a bottom-up
and beverages); B. Entertainment; C. estimate:
Decorations, Including Centerpieces; D.
Photographer. Roughly let’s assume that 1. Go to each WBS sub-task and
A accounts for 75% of the cost of a write out an objective of each.
wedding, B accounts for 15%, C 2. From the schedule, determine
accounts for 4%, and D accounts for 6%. how much time has been
No matter what one’s budget is, if you allocated to the task.
tell me how much you have available to 3. For each sub-task, from the
spend, I’ll tell you what you’re able to objective and schedule,
get for that amount since I can apply determine how many people are
these percentages toward the total required and at what level—this
budget you have to spend. Mind you, should be broken out on a week-
you might end up using your cousin’s by-week basis.
son to spin records to provide the 4. From the objective, determine
entertainment, but it’s still a reception, what material or subcontracting
nonetheless. Any project where the is required and get quotes on
amount of work can be scaled up or each item.
down to meet the available budget is a 5. Repeat this for each remaining
good candidate for apportioned task
estimating. 6. Apply the appropriate labor and
overhead charges to the tasks.
It’s worth noting that, although 7. Each sub-task rolls up to give the
parametric estimating requires a larger overall estimate for a major task.
sample of past project data, the tendency Each major task rolls up to give
to use too small of a sample size or to the estimate for the project.

gaps. Many bottom-up estimates will
The advantage of this method is the have subtasks that were estimated via
ability to give as accurate an estimate as expert opinion or parametric methods. If
possible. When estimates are required to your projects historically are costing
be written down and signed by two much more than what had originally
people (the estimator and a reviewer), been planned there could be one of many
people can be held accountable for the reasons why this is so. If you’re
estimates. Requiring the person who confident that your project manager is
will be responsible for managing the managing the project well and your
work to estimate it as well increases the project team is performing the work to
chances of it being as accurate as the best of their abilities the first thing
possible. Bottom-Up estimates can have that should be considered is to look at
a margin of error of about 10% when the method used to create the estimates.
created by skilled, experienced
estimators and individual work package
estimates are based on past experience. About the Author
One negative aspect of this method is the
time (and cost) commitment required to Ed Kozak, M.S., M.B.A., PMP is the
make the estimate. Another is that it President and CEO of Successful
gives the estimator the ability to “pad” Projects For Leaders, international
the estimate, in other words, to falsely experts in project management process
add in additional money to the estimate improvement. The staff of Successful
due to lack of confidence in the estimate. Projects For Leaders work with
It is important to remember that this companies along three main points of
estimate is only as good as the WBS it’s focus. First, they help companies
derived from. If shortcuts were taken improve their profitability by cutting
when the author(s) constructed the WBS wasteful project costs (upwards to 50%
and tasks were left off then the estimate or more) and improve their overall
will not include budgets for those tasks. management of projects in order to
reduce risk, schedule slippage, and
unnecessary spending on product
In summary, four main types of rework. As a result their clients are able
to exert more control over their projects;
estimating techniques are available when
estimating projects budgets. The choice improve target schedule performance;
of which one to use varies on the type of monitor and control cost performance
work to be done, the availability of past better; increase their success at hitting
project data, the level of comfort of the budget estimates; improve quality and
accuracy of the estimate, and the amount satisfaction; and recognize the
of time set aside to create the estimate. substantial financial benefits that come
It is a novice mistake to think that only along with that.
one method could be and should be used
to create the budget for a project. In Second, Successful Projects For Leaders
fact, estimators may use one method as is hired as project turnaround experts
far as they can take it and then use one and is brought in on critical projects that
or more different methods to fill in any are in the midst of schedule, budget,
and/or quality issues or projects that are

having continual setbacks. They analyze offices, and project management and is a
the problems, set a new budget and frequent conference speaker.
schedule, and work with the incumbent
project management team to bring them
to completion.

A third benefit that Successful Projects
For Leaders offers is their availability to
be out-sourced by Organizations to serve
as the Chief Projects Officer. In this
role, Successful Projects For Leaders
only develops standards and practices
directed at the effective execution of
projects and the attainment of schedule,
cost, scope, and quality objectives, but
also communicates enterprise-level
objectives to the respective project
groups in the most-appropriate way for
them to follow and communicates
project information to Management.
This overcomes the problem common to
many organizations that no connection
between Operations and project groups
exists and no structured, consistent, and
meaningful flow of information between
these two groups occurs, allowing
Management to determine if efforts are
efficient and effective, if projects are
still the best ones to support strategic
objectives, whether there are
performance issues associated with
meeting objectives.

Ed is an accomplished professional with
has over twenty-three years experience
as a consultant, manager, executive,
facilitator, and instructor that includes
project/program manager experience in
the private and Government sectors
managing multi-year, multi-million
dollar programs for his clients in fields
such as IT, healthcare, research,
development, and manufacturing. He
brings his expertise to management
teams in strategic planning, process re-
engineering, program management

Don't Add Risk And Double Investment Requirements By Estimating Project Budgets Incorrectly

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