Course Learning Outcomes for Unit VI

Upon completion of this unit, students should be able to:

1. Apply best practices for project budgeting and cost management procedures.

2.1           Derive a project cost estimation and budget.

1. Prepare a final project report.

5.1           Explain basic concepts of projects and project success as it relates to cost estimation and budgeting.

1. Plan project procurements by identifying methods to manage procurements and monitor contract performance.

8.1           Explain basic concepts of project procurement and monitoring contracts.

Required Unit Resources

Chapter 8: Cost Estimation and Budgeting, pp. 274–298

Unit Lesson

Procurement

Many times in organizations, the procurement department, sometimes known as the purchasing department, has specific relationships with vendors and suppliers to procure materials for the organization. With the onset of a new project, those established relationships and vendors or suppliers may not be able to provide the needed materials. Thus, the project manager (PM) may have to create new relationships with outside vendors and suppliers. For the project, procurement will involve several processes and will have to be managed. We could say the basic processes are as shown below.

Procurement management starts with planning. Planning involves discovering what materials are needed and the potential vendors and suppliers that may be used. In many cases, the organization will perform a needs analysis and may need to send out a call for bids. In some cases, a request for proposal (RFP) or a request for quotation (RFQ) is issued. According to Pinto (2019), an RFP is a “document used to request proposals from prospective sellers of products or services” and an RFQ is a “document used to request price quotes from prospective sellers” (p. 549). Sometimes, this process is known as a sourcing strategy or outsourcing strategy. The PM will need to negotiate with suppliers or vendors and then select the best bid. Once the supplier is chosen, there will need to be a contract approved by the legal department. After the contract is signed, there will need to be some controls in place, including the following.

• Are we getting the materials in the promised timeframe and of the proper quality?
• How will we handle invoicing?
• Who will pay the invoices, and how will we keep up with that? The last thing we want to do is overpay or underpay a vendor. We also do not want to pay them too early or too late.
• Finally, there will be a closing process where the contracts are closed. Closing could be based on final delivery of materials or reaching the end date of the contract.

A part of the procurement process involves contract management. Contract management simply means keeping contracts visible through the life cycle of the contracts (i.e., not losing track of expectations, delivery dates, and payment dates).

Budgeting

Until now, most of what we have discussed involves managing resources, and the emphasis is on the time constraint. Now, we consider the cost constraint and cost management. Intuitively, we know cost is important. It is very important for organizations and their bottom line. Cost is included in budgeting and the organization’s strategic goals. Some of the first questions asked in a project is when a product is needed and how much is in the budget. Unfortunately, many times, we do not know the exact cost. All we can do is estimate the cost and work around that number. There are several different costs to consider as well.

Labor costs: As mentioned previously, a big project cost is our labor costs. How many people will we need to work on this project? Do we take employees away from their normal work, or do we pay current employees overtime? Do we hire new employees? Will we need skilled workers or technical experts? What about the cost of overhead? Overhead costs are costs not specifically slated for work hours. Where do we put health benefits? What about training costs or 401K benefits?

Materials costs: The cost of materials is another big cost on many projects. For an information technology (IT) project, the cost of materials might not be so high, but what about building projects? Would renting a crane fall under the materials category?

Subcontractors’ costs: This cost involves hiring someone from outside the company for their services. It could be technical experts or product experts or marketing experts.

Equipment and facilities costs: This cost involves the rental of equipment or an office facility. We consider this any cost outside of the employee’s workspace.

Travel costs: Travel costs include the cost of sending an employee offsite. For example, if employees are scouting for a new construction site and have to stay in a hotel overnight, then this cost would include air travel costs, hotel, meals, car rental, and meals.

Classifying costs: It is important to note that there are other ways to classify costs. For example, there are direct or indirect costs, recurring or nonrecurring costs, fixed or variable costs, and normal or expedited costs.

More in-depth explanations of each of these costs can be found in the textbook, but we will discuss the basics.

Direct vs. indirect costs: Direct costs are those costs that are easily linked with a specific object such as a product, department, or project. Some examples are labor costs, equipment, and materials. Indirect costs are expenses linked to overhead and general expenses. Overhead refers to necessary business expenses. For

example, if we were talking about labor costs, paying the employee a salary is a direct cost, but the cost associated with his or her health insurance or pension would be an indirect cost. Other types of indirect costs might be depreciation, insurance, and taxes. Sometimes, it can be a challenge to determine if the cost is direct or indirect.

Recurring or nonrecurring cost: According to Pinto (2019), recurring costs are those continuing over the project’s life cycle. Nonrecurring costs are usually those that are applied one time. For example, most of the major costs, such as labor and materials, are recurring costs because you book them as you go. If you have an employee who gets paid every two weeks, you should not charge his or her labor costs at the end of the project. However, if you needed to send an employee to a training class, it would be a one-time cost or a nonrecurring cost.

Fixed or variable costs: Fixed costs do not vary, whereas variable costs will change while being used. As an example, renting a building for a specific amount every month would be a fixed cost. A good example of the variable cost might be fuel cost. The cost of fuel depends on how much we use the machinery.

Normal or expedited costs: We have already discussed the possibility of expedited costs in a previous lesson. Normal costs are those costs that are planned. Expedited costs occur when there are unplanned costs associated with needing to speed up the project. For example, if we are falling behind in our project and need to allow some workers to work overtime, then that overtime falls under expedited cost.

After reviewing the several types of cost, it should be clear that estimating the cost of the project is a complex endeavor but is very important. It is crucial for the PM to clearly define the costs early in the project planning process and be as accurate as possible. In many cases, the PM needs to estimate cost based on milestones or deliverables. The PM may need to estimate the cost based on different work packages. For example, the PM may need to report the cost for the IT deliverables, a cost for product development, and a cost for marketing.

To add even more complexity, there are different types of cost estimation methods. As Pinto (2019) noted, the PM can give ballpark estimates or comparative estimates. An explanation of these methods can be found starting on page 280 in your textbook.

Now, let’s calculate some labor costs for an IT team.

Hourly rate:                   $40/hr.

Hours needed:               160

Overhead rate:              35%

Hourly rate        Hours needed               Overhead charge                       Total direct labor cost ($40)      x        (160)                  x                   (1.35)                    =                      $8640.00

What if the four team members had different rates of pay and were needed for different lengths of time?

We would calculate by multiplying each line as shown below.

Of course, these are simple examples. You may have several employees for whom to calculate the labor costs. You may have some indirect and direct labor costs. You may have some expedited labor costs if some of your employees have to work overtime. We would then add our total direct labor costs to our other costs.

Another concept in budgeting involves top-down budgeting vs. bottom-up budgeting. Top-down budgeting includes input from the top level of management. According to Pinto (2019), top-down budgeting means the PM is estimating cost based on senior management experience. Top-down budgeting may be the method chosen if upper management has a project budget in mind and that is the bottom line. Bottom-up budgeting means that you start with the work breakdown structure (WBS) to calculate costs.

Advantages and Disadvantages

An advantage to bottom-up budgeting is that there will be a lot of detail in creating the budget from the start. A disadvantage might be that it would be harder for upper management to control the budget. An advantage to top-down budgeting is that there is good cost control, but a disadvantage is that it might cause issues at the different levels of management.

Problems with Cost Estimation

There are many ways a PM can cause issues with cost estimation. The PM could underestimate costs or overestimate costs. As discussed before, in many cases, the duration for an activity has to be estimated. What if the estimates are not correct? Another issue might involve technical issues. For example, what if we find that a needed technology tool must be updated? What if a necessary prototype is flawed? These types of issues can cause delays or additional costs for updates. Another problem with cost estimation might be poor definition. What if the PM lacks clear goals for the project? What if the PM lacks a clear initial scope development for the project? We have already discussed the high cost of scope creep in a previous lesson.

Another problem with cost estimation might be changes to the specifications. This problem is common in the IT world. The user might say “I forgot I need this functionality as well.” Well, the added functionality could add days or weeks to the project time. A final problem with cost estimation might be external factors. For example, what if we have a construction project in another country, and we discover that additional permits are needed? If it is a local project, what if we have to present our plans in front of a zoning commission, and they are resistant to accepting our project?

These are just a few of the problems that can occur with cost estimation, but the problems mentioned are the most likely to be encountered. Most of the issues will fall under one of these categories.

The information presented in this unit lesson is a high-level overview of how to estimate costs in a project. As discussed, there are many ways to calculate total project cost. The methods used will likely be different from organization to organization. In some cases, the organization has refined its cost estimation and budgeting process over time based on past projects and best practices.

Reference

Pinto, J. K. (2019). Project management: Achieving competitive advantage. (5th edition). New York, NY: Pearson