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Estimating Effort: Part 1

by Bill Duncan

This series of articles is extracted from a similar series I wrote for Projects@Work a couple of years ago. I’m posting it here in reaction to my review of Josh’s articles on Earned Value where he (in my opinion) used the term “estimate” when he should have said  ”budget.” Many of the terms related to estimating are used either inconsistently or imprecisely. Future items will address some “how tos,” but first, let’s take a minute to establish some common terminology.

Estimate. An estimate is an informed assessment of an uncertain event. Informed means that you have an identified basis for the estimate. Uncertain recognizes that multiple outcomes are possible. For example, if I tell you that there are two people standing outside the door, that one is male and the other female, and that one is 6’ 6” (200 cm) tall and the other is 5’ 2” (158 cm) tall, which would you guess is the female?

Most people will predict that the tall person is male. Most people will make an informed assessment of this uncertain event based on their knowledge that men tend to be taller than women, that few women are as tall a 6’ 6”, and that few men are as short as 5’ 2”. But what if I said the woman was a professional basketball player and the man was a jockey? Most people will now predict that the tall person is female.

Guess. A guess is a special kind of estimate—one where we do not have enough information to make an informed assessment. Note that in the above examples I used predict rather than guess since you do have enough information to make an informed assessment. For example, if I asked you to predict which person outside the door was taller, the person on the right or the one on the left, you would be forced to guess. In my experience, it is rarely necessary to make a true guess when working on a project.

Effort. Effort is an expenditure of physical or mental effort on the part of a project team member. We almost always measure effort in terms of staff hours. In many application areas (IT, NPD, pharma, consulting, architecture), most project estimates will be effort estimates. If you purchase resources from outside your organization, you may not see the effort estimates that were used to develop the cost estimates, but they’re there somewhere.

Cost. Cost is a measure of resource usage—employees and contractors must be paid, equipment must be bought or rented, and so on. Cost is usually expressed in monetary terms (dollars, euros, renminbi, etc.), but it can also be expressed in terms of hours of effort. One advantage of using monetary units instead of effort hours is that it should make comparisons between projects or among activities on the same project easier.

Another advantage of using monetary units to express cost is that the financial people in your company understand the language of money. One disadvantage is that monetary units can distort the numbers if the hourly rates are not reasonable. For example, if you use a rate of $100 per hour for an employee making $50,000 per year, and the same rate for someone making $150,000 per year, your cost estimates will misrepresent the actual cost of any project that has a preponderance of effort from one or the other.

Price. A price is what you charge someone for something. Prices are always (well, almost always) expressed in monetary units. Prices can reflect rates (e.g., $100 per hour) or totals ($500,000 for the entire project). Pricing is a business decision. It is usually derived from the estimate, but the estimate is not the price—if we are selling products or services to someone, we can charge more or less than our estimated costs. Even if we know for certain what the costs are or will be, we can still charge a different price.

For this series of articles, I’m going to assume that most readers are either managing internal projects or developing estimates in order to support a pricing decision that will be made by someone else (as is often the case for project managers working for a consulting firm). As a result, I am not going to cover pricing past the point of defining it.

Budget. A budget is a management control or metric (I prefer the term metric since control has negative connotations to some). A budget is a type of plan. Most people use the term only with regard to monetary metrics, but you can have effort budgets or schedule budgets as well. Project budgets should be derived from the project estimates.

Project budgets are not absolutes! Or at least they shouldn’t be. If a project is budgeted for $1,000,000, all of the stakeholders should understand that that number is a target. It is what the team expects to spend based upon what it knows today. If the team can find a way to spend less and still deliver the full scope, it should do that. If it needs to spend more, that should generate a discussion with the funders to decide what to do.

The project budget is not the same as the project price, even for a project done under contract. The seller can price the work for an amount that is different from its internal management metric.

Baseline. A baseline is very nearly a synonym for budget. There are two subtle differences. First, project baselines are normally time-phased. While I might say that the budget for my project is $500,000, I wouldn’t really have a baseline unless I had also defined when I expected to spend that money—how much in week 1, week 2, and so on. Second, the term baseline implies some level of formal approval. I can prepare a budget for an activity or a project, but it isn’t really a baseline until the relevant stakeholder(s) have agreed to it.

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{ 14 comments… read them below or add one }

Dr. PDG December 13, 2008 at 9:27 am

Hi Bill,
Nicely written!!

About the only suggestion I can add is under “price” I think you should state that it includes or should include:
1) Direct costs of producing/procuring the goods or services;
2) Indirect or Overhead costs associated with producing/procuring the goods or services;
3) Any contingency to cover potential variations to the underlying estimate;
4) Profit margin.

As strange as it may seem, one of the biggest misunderstandings I find in clients is the definition of cost vs price. Once explained, it becomes obvious, but especially when using the “old” EVM terms “Actual Cost of Work Performed”, I hate to say how many contractors believe that to use EV, they need to tell the owner the COST of their products of services and not the contractor’s selling price. (The owner’s cost, not the contractor’s cost)

BR,
Dr. PDG, Jakarta

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jeobbymow February 27, 2012 at 6:00 am
DrPDG February 27, 2012 at 10:50 pm

Very well written, Bill!!

About time you considered getting AACE certified? Definitely have moved well beyond the thinking of the thinking and level of detail contained in the PMBOK Guide…..

Looking forward to your book!!!

BR,
Dr. PDG, Singapore
http://www.build-project-management-competency.com

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mandingOO June 27, 2012 at 10:23 pm

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suma June 28, 2012 at 4:44 pm

i want to know example about Estimation to Complete(ETC) and Estimation at Complete(EAC) in project management.
i got confused ,
sa1009@live.com
suma,BIT student

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DrPDG June 28, 2012 at 6:24 pm

Suma, the very simple answer is you take the Actual Cost of Work Performed (ACWP or PV) to date + the Estimated Costs to Complete (ETC) = Estimated Cost At Completion (EAC)

My best advice would be to go directly to the source- download the DAU “Gold Card” 2012 https://acc.dau.mil/CommunityBrowser.aspx?id=19577 as that is the definitive reference on the Earned Value formulae and terminology.

BR,
Dr. PDG, Narita Airport, Tokyo
http://www.build-project-management-competency.com

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Glen B. Alleman June 28, 2012 at 6:39 pm

Paul, the Actual Cost of Work Performed is not PV it is AC (Actual Cost). PV is Planned Value, BCWS.

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DrPDG June 28, 2012 at 6:49 pm

Whoops!!! Thanks for the correction, Glen…… (Just got off a “red eye” here in Narita airport)

But it brings up a point- why does PMI feel they have to “reinvent the wheel” by creating yet another set of acronyms?

ACWP, BCWP and BCWS have been around for what, 40-50 years now and a bunch of IT people come along and want to change things? I notice DAU hasn’t changed……

BR,
Dr. PDG, Narita Airport, Tokyo
http://www.build-project-management-competency.com

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Glen B. Alleman June 28, 2012 at 7:05 pm

It’s not PMI. DOE uses PV, EV, and AC. It actually makes more sense.

The reasons DoD hasn’t is there are IT systems, forms, and databases full of the old names.

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Bill Duncan June 29, 2012 at 3:09 am

Glen — the 2 character terms may currently be used by DOE, but they were suggested by Quentin Fleming and used in the second edition of the PMBoK Guide before they were adopted by DOE.

Personally, I prefer “Scheduled Cost” to “Planned Value.”

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Glen B. Alleman June 29, 2012 at 8:59 am

Well if anyone should have the final word, it’s be Quentin.

“scheduled cost” doesn’t speak to “value,” just cost. “Planned Value” says I plan to earn this value over the period of performance. Now what did I actually earn? That’s what Earned Value says.

These two can now be compared in the same units of measure – value. That’s the logic of Quentin and PMI. For those using EVM for the first time this makes it clear that the “plan” says the goals, and the measure says to outcome.

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Bill Duncan June 29, 2012 at 11:37 am

Glen –

I understand (and mostly agree) with your argument. It’s the same rationale I used to give for why Quentin had suggested PV and for why PMI had decided it was “good practice” even before anyone was using it. Personally, I doubt that Quentin’s idea would have taken hold if PMI hadn’t included it in the second edition of the PMBoK Guide.

However, “value” has other meanings. From the sponsor or customer’s perspective, there is little value in the project. Projects are costs; value comes from using the product of the project.

In teaching the approach, I’ve found that “scheduled cost” goes down easier with newcomers. You can plan when you will “earn value” or when you will spend the money. As long as you are doing 0/100, there is no real difference between the two.

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Glen B. Alleman June 29, 2012 at 3:58 pm

Bill,

This is a common misunderstanding that just has to be “gotten over.” The Value is the budget, that’s how you value the work – the sunk cost of producing that outcome. That’s how a manufacturing line does it. The agilest try to make it an issue – Scott Ambler e.g. – but it’s a non-starter.

“scheduled cost” is close to BCWS, but “this is what I plan to value this work at – what I’ve invested in the work.” “How much of that value did I earn back at this point in time?” “Am I going to earn back what I invested in the production of this item?”

The business value of the manufactured part is set by sales and marketing, that’s still useful, but not the person making the part.

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DrPDG June 29, 2012 at 4:15 pm

Glen, I am with Bill 100% on this. Value is a perception that often has very little to do with the cost to produce goods, products or service or the level of effort that went into producing them. (i.e. paintings and other art work; diamonds or even fundamental basics- water in the desert or oil)

Cost on the other hand has a very well defined meaning which is quite different from that of “value”. The way I teach it is very similar to Bill’s approach but while he uses “scheduled costs” I am a strong advocate of Activity Based COSTING, which again portrays a much more accurate and understandable concept. (I use purchasing bananas in the local fruit market)

BR,
Dr. PDG, Boston, MA
http://www.build-project-management-competency.com

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