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Reliable cost estimates are necessary for all projects. Without a cost estimate, it would be impossible to prepare a business plan, establish detailed budgets, predict resource requirement or control project costs.
In the process of cost estimation, the Project Cost Engineer uses either one or the combination of the following tools and technique:
Methods of Cost Estimation in Projects
- Expert Judgement
- Analogous Estimating
- Parametric Estimating
- Bottom-up Estimating
- Three-point Estimating
- Data Analysis (Alternative analysis/Reserve analysis)
- Project Management Information system
- Decision making (voting)
1) Expert Judgement Method
Expertise should be considered from individuals or groups with specialized knowledge or training in team and physical resource planning and estimating.
Expert judgment, guided by historical information, provides valuable insight about the environment and information from prior similar projects.
Expert judgment can also be used to determine whether to combine different methods of estimation and how to reconcile differences between them.
2) Analogous Estimating Method
Analogous cost estimating uses the values such as scope, cost, budget, and duration or measures of scale such as size, weight, and complexity from a previous, similar project as the basis for estimating the same parameter or measurement for a current project.
When estimating costs, this technique relies on the actual cost of previous, similar projects as the basis for estimating the cost of the current project.
It is most reliable when the previous projects are similar in fact and not just in appearance, and the project team members preparing the estimates have the needed expertise.
3) Parametric Estimating Method
Parametric estimating uses an algorithm or a statistical relationship between historical data and other variables (e.g., square footage in construction) to calculate resource quantities needed for an activity, based on historical data and project parameters.
For example, if an activity needs 4,000 hours of coding and it needs to finish it in 1 year, it will require two people to code (each doing 2,000 hours a year). This technique can produce higher levels of accuracy depending on the sophistication and underlying data built into the model.
4) Bottom-up Estimating Method
In the Bottom-up estimating method, team and physical resources are estimated at the activity level and then aggregated to develop the estimates for work packages, control accounts, and summary project levels.
Bottom-up estimating is a method of estimating a component of work. The cost of individual work packages or activities is estimated to the greatest level of specified detail. The detailed cost is then summarized or rolled up to higher levels for subsequent reporting and tracking purposes.
The cost and accuracy of bottom-up cost estimating are typically influenced by the size and complexity of the individual activity or work package.
5) Three-Point Estimating Method
The accuracy of single-point activity cost estimates may be improved by considering estimation uncertainty and risk and using three estimates to define an approximate range for an activity‘s cost:
• Most likely (M): The cost of the activity, based on realistic effort assessment for the required work and any predicted expenses.
• Optimistic (O): The activity cost based on analysis of the best-case scenario for the activity.
• Pessimistic (P): The activity cost based on analysis of the worst-case scenario for the activity.
Depending on the assumed distribution of values within the range of the three estimates the expected cost, cE, can be calculated using a formula. Two commonly used formulas are triangular and beta distributions. The formulas are:
- Triangular Distribution
E = (O+M+P)/3
- Beta Distribution (from a traditional PERT analysis)
E = (O+4M+P)/6
Cost estimates based on three points with an assumed distribution provide an expected cost and clarify the range of uncertainty around the expected cost.
6) Data Analysis Method
A data analysis technique used in this process includes but is not limited to alternatives analysis. Alternatives analysis is used to evaluate identified options in order to select the options or approaches to use to execute and perform the work of the project. Alternatives analysis assists in providing the best solution to perform the project activities, within the defined constraints.
Instead of overestimating each cost, money is budgeted for dealing with unplanned but statistically predictable cost increases. Funds allocated for this purpose are called contingency reserves.
7) Project Management Information System Method
Project management information systems can include resource management software that can help plan, organize, and manage resource pools and develop resource estimates.
Depending on the sophistication of the software, resource breakdown structures, resource availability, resource rates, and various resource calendars can be designed to assist in optimizing resource utilization.
8) Decision-Making Method
Some decision techniques are unanimity, majority, plurality, points allocation, and dictatorship. For unanimity, everyone must agree; there is a shared consensus. A majority or plurality is usually determined by a vote. For a majority, the decision must be agreed to by more than half the participants.