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Cost Estimating
Cost estimating is the process of determining the likely cost of performing a defined scope of work at a time
in the future. As with any attempt to predict the future, it is unreasonable to expect a cost estimate to be
100% correct. The estimating process should be focused on determining a reasonably accurate estimate
based on defined assumptions for a reasonable expenditure of effort. The estimate should be supported by
appropriate risk management strategies1 and management reserves based on an appreciation of the likely
levels of variability and uncertainty inherent in the estimate.
The core stages in developing a pragmatic and reasonable process for cost estimating are:

Plan the estimating strategy based on available estimating resources and available budget for preparing
the estimate.

Determine the most appropriate approaches to develop the estimate. Select the most appropriate
methodology consistent with the organisations culture and objectives.

Consider any estimating inputs to the project delivery strategy such as assessing the cost effectiveness of
alternative methodologies and strategies.

Develop systems to ensuring the estimate covers 100% of the scope (this is nearly impossible but
essential), in particular ensure potential future suppliers and subcontractors have included within their
submitted price all of the scope of work you expect them to price.

Determine the appropriate estimating technique to use (in most projects a combination of these options
are used to obtain the best estimate):
o

Analogous: comparing the current project with a similar completed project and making
appropriate adjustments. This is relatively quick but requires expert knowledge. Generally
seen as the least accurate approach2 but this depends on the degree of knowledge and
expertise.

Parametric: using adjusted historical data to price defined elements of the project such as
the cost per function point in software development and the cost per square (10 sq m) in
domestic construction work.

Bottom up (or detailed) estimating: the cost of each resource used in the project is
determined and multiplied by the quantity required. This is the most expensive estimating
process and the most accurate. A detained engineering estimate can be as accurate as -5%
to +15%.

Vendor bid analysis: where prices for different components of the project are obtained from
the market and compiled to generate the cost of the overall project.

Determine the allocation of organisational overheads to the project costs and how these will be applied.

Develop or adjust estimating rates for work to be priced internally including:

Loaded hourly cost rates.

o
o

Loaded cost per unit or element (parametric estimates).

Balancing the allocation of costs between project overheads and loaded cost rates.

Assess the likely levels of estimating error to develop contingencies and reserves:
o

Variability in estimated costs and rates (there will always be a level of variability).

Estimating errors (omissions / duplications).

For more on risk management see: http://www.mosaicprojects.com.au/WhitePapers/WP1047_Risk_Management.pdf

In most situations the degree of accuracy associated with an analogous estimate is considered to be a Rough Order
of Magnitude (ROM) estimate with a range of -25% to +75%.

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o

External events and changes in the market (eg, suppliers ceasing to trade).

Assess future cost movements (inflation)

Identify estimating and other risks and link to the projects risk management processes. The way the
estimate has been developed is of itself a risk issue3, plus there will be identified risks arising from
interaction with suppliers, contractors and others.

Link estimating to procurement to minimise risk exposure from suppliers and subcontractors.

Once the estimating process is properly planned, the actual work of developing the estimate can be
undertaken with the final output the expected cost of the work and a recommended level of management
reserves. The US Government Accountability Office has developed a comprehensive guide to developing
credible cost estimates and then managing the budget for a project using Earned Value. The GAO Cost
Estimating and Assessment Guide is particularly useful for major projects4.

Cost Estimating -v- Pricing

The cost estimate is the net cost of completing the scope of work. The price charged for the work to a client
should consist of the following elements:

The estimated cost

A reasonable level of management reserves (contingency) to cover both the expected level of variability
in the cost price plus an allowance for identified risk events.

An amount of profit to reward the organisation for the risks involved in undertaking the work and to
compensate for the use of the organisations capital to undertake the work. This would normally exceed
the amount received from a safe investment (eg, a bank deposit).

The final price is always a subjective management decision based on the defined items above, an assessment
of the market and what is likely to be an acceptable price and views on the level of competition from others
combined with the organisations level of desire to win the work.
The above factors are focused on a competitive estimate to win work by a commercial bit or tender. If the
work is internal to the organisation, the expected benefits to be realised5 define an acceptable price.

Cost Estimating & Risk Minimisation

Estimating what something will cost in the future is a risk. It is impossible to forecast what the element of
work will actually cost. The estimating processes need to balance the mutually exclusive options of seeking
the lowest practical cost estimate and minimising risk. Risk is reduced if the estimated values are inflated but
the unnecessarily high cost estimates tend to make competitive bids too expensive to win work and internal
project too expensive to undertake. Decision need to be made to balance cost and risk within the risk
tolerance levels of the organisations management. Some of the decisions that need to be made include:

In-house resources or subcontract?

o

Direct in-house resources are subject to more control, direction and motivation but any
estimating errors in the quantum of effort needed to accomplish the work are a direct cost to
the project (as are supervision, quality defects, etc).

For more on the effect of cognitive biases see: http://www.mosaicprojects.com.au/WhitePapers/WP1069_Bias.pdf

Download a copy of the GAO Cost Guide: http://www.mosaicprojects.com.au/PDF/GAO_Cost_Guide.pdf

For more on benefits realisation see: http://www.mosaicprojects.com.au/WhitePapers/WP1023_Benefits_and_Value.pdf

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o

Subcontractors can be expected to carry the consequences of their estimating errors and
perform the work for the agreed price. However, there is a loss of direct control and the need
to manage contracts6. At least some of the risk is transferred to the subcontractor.

Low price or safe suppliers and subcontractors?

o Low bids from suppliers and subcontractors allow the overall estimate to be lower increasing
your competitive advantage. The low bid may be due to a competitive advantage held by the
supplier/subcontractor
o The low bid contractor may have made an error in its estimating processes. In this
circumstance the contractor may refuse to take on the work or chose to take on the work
with the intention of making claims to recover its loss or delivering a lower quality product.

Firm Fixed Price or Cost Reimbursable contacts?

o Fixed price offers no insight into the way the contractor calculated its bid and tends to make
the price changes expensive (there is no base for comparison).
o Cost reimbursable allows insight to the pricing process but requires additional estimating to
determine the cost.

The combination of options that provides the best (lowest) cost outcome within an acceptable risk parameter
requires careful judgement within the organisations overall governance processes7.
Major contractors divide the work between suppliers and subcontractors their supply chain. The art of
managing the estimating process is to ensure all of the work is portioned out to trade packages and there are
no duplications. The art of estimating is to ensure 100% of the work is priced; but only once! Plus the
accepted prices used in the estimate have been risk assessed on the likelihood of the quoted price being
achieved by the supplier.

Appropriate Levels of Detail

Adding detail to an estimate will not automatically improve accuracy. Accuracy is only improved if
improved knowledge or insight is achieved. Processes such as costing individual peoples efforts against work
on scheduled activities can only add value if information being used is based on new and enhanced
information preferably gathered from the person actually involved in the work (or from knowledge of the
specific person). This type of estimating is appropriate for short term work but is pointless for tasks
scheduled months in the future where the precise scope of work is not known and the people who will be
doing the work are not defined8.
Adding unnecessary detail increases costs, increases the workload, reduces visibility and reduces flexibility.
Superficial detail will also change expectations of more senior managers who may believe the information is
valid and therefore believe it is safe to reduce contingencies.

Linking Cost Estimates with the Schedule

Apart from very small short term projects (3 to 6 months and under $200,000) attempting to directly
integrate the cost estimating process with the scheduling process in fraught with difficulty. Even on these
smaller projects, direct linking is not really feasible unless the primary source of all costs is staff directly
employed on the work.
6

For more see The Meaning of Risk in an Uncertain World: http://www.mosaicprojects.com.au/Resources_Papers_040.html

For more on governance see: http://www.mosaicprojects.com.au/WhitePapers/WP1033_Governance.pdf

For more on estimating detail see: http://www.mosaicprojects.com.au/WhitePapers/WP1052_Time_Estimating.pdf

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Most normal projects require a degree of integration between cost and schedule. This is usually achieved by
developing a WBS and integrating time, cost, scope, risk and quality at either the Work Package level or the
Control Account level9.

Dealing with objections

It is not uncommon in internal projects and negotiations, that your carefully prepared project estimates have
to be justified or defended if the client or sponsor thinks the numbers are too high. If you have done the
estimating properly, reducing the price (or time) in the face of an objection simply creates a bigger problem
later when the project overruns its (reduced) costs or time!
Information is the key to validating your work. You should be able to defend the estimate by demonstrating:

Your understanding of the work

The estimating technique(s) you used

Your estimate of the effort hours, duration and cost

The detailed estimating information in case the sponsor would like to review

Your estimating assumptions

The level of uncertainty as reflected in the estimating range

This level of information gives you the facts to respond to the challenge, and it will stop many challenges
because people will have difficulty disputing your facts. The keys to this part of discussion are your
credibility10 and the quality of the information you have presented.
Once the credibility of your estimate is accepted based on your estimating rigor, the discussion can then
proceed to alternatives if the sponsor still thinks the numbers are too high, or cannot afford the solution at
that cost, there are a few alternative options:
Determine if the client has any additional information that would allow you to revise your assumptions
and perhaps revise the estimate. For instance, if a critical end-date now has some flexibility, perhaps
the estimate can be revised based on this new information.

Determine whether high-level requirements and functionality can be scaled back. In many cases, the
original set of features and functions is more of a wish list. After seeing a price tag, it is very possible
that the client can live without certain features.
If you included a high contingency to reflect a high estimating risk, ask the client for more time to
gather more detail for the estimate. This may result in there being less uncertainty and risk, and allow
you to reflect this as a smaller contingency.

No estimate is perfect, what sensible sponsors and clients are seeking is reassurance you have done the best
job possible in the circumstances and the costs are realistic. This requires them to believe you are skilled and
credible and our estimating processes were rigours and effective. .

Managing the Estimate Lessons Learned

Estimating normally precedes the start of a project or is completed in the early concept and planning phases.
Whilst the estimate may go through several iterations as the final scope of the project is firmed up the normal
expectation is the estimate should be converted to the cost baseline before the main execution phase begins.
9

For more on the WBS see: http://www.mosaicprojects.com.au/WhitePapers/WP1011_WBS.pdf

For more on credibility see: http://mosaicprojects.wordpress.com/2013/04/27/credibility/

10

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The cost baseline provides one of the key foundations for the on-going management of the project work. The
cause of any variance from the baseline should be identified and options developed to lock in gains and
mitigate losses. This is the domain of project controls, cost engineering, Earned Value Management and
project administration.
Estimating processes are used to price variations and occasionally to re-estimate the project if the original
cost baseline is found to be invalid. However, numerous surveys have shown in most circumstances, reestimating the project costs to complete is less accurate then applying Earned Value calculations. The
exception is where major changes in the structure of the project team and/or management have occurred.
On the completion of the project (and occasionally during the execution of the project), it is important to
undertake an effective lessons learned11 study to determine the voracity of the estimating process and
identify areas for improvement. A major advantage of retained organisational experience is the capability to
accurately price work in a particular domain and understand and manage the associated risks.

This White Paper is part of Mosaics Project Knowledge Index

to view and download a wide range of published papers and articles see:
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For more Cost Management White Papers and annotated references see:
http://www.mosaicprojects.com.au/PMP_Sup/PMP_Mod07_Cost.html

11

For more on lessons learned see: http://www.mosaicprojects.com.au/WhitePapers/WP1004_Lessons_Learned.pdf

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