Almost every project requires an estimate.
Since a project is, by definition, temporary, somebody must approve a budget for it. Which means they must know how much to approve.
The available types of estimates can be categorized into the following groups:
- Source of Data
- Estimating techniques
In many industries, project estimates start very broad and get refined over time. Large infrastructure, mining, or industrial projects use this model. In other industries, a very detailed estimate will suffice.
There are five types of estimates based on accuracy:
- Order of Magnitude
Also called Rough Order of Magnitude (ROM) or Rough Cost Estimate, or Conceptual Estimate, this type of estimate is used for project screening, or deciding which among several projects to proceed with. The project should be defined around 0 – 5%, and the accuracy is in the range of 30 – 50%. It does not break the project down into parts. Rather, it involves determining the overall units and scaling them to a known value. For example, the estimate of a house is scaled by square footage from a previous house building project.
This type of estimate is used to determine the feasibility of a project and proceed with a decision to carry out the project (a go/no-go decision). Large infrastructure projects develop this type of estimate in order to present the board with the information to make the decision to carry out or abandon the project. The project is defined around 5 – 20%, and the accuracy is in the range of 10 – 25%. The exact project definition level is determined by the minimum amount necessary to make the decision.
Also called budget level estimate, this type of estimate is used to aid in a decision to choose among the various options available. The options for the final product, its features, and configuration are analyzed and estimated to make a decision to proceed with one alternative over the others. Hence, the estimate needs only to be as detailed as necessary to distinguish between alternatives. The project definition level is about 10 – 40%, and the accuracy of the estimate is 10 – 15%.
Upon design completion, the project costs are well known. This estimate breaks down the project into its constituent parts and uses all available information to assign a cost to each part. The pieces are rolled up into an overall estimate, and contingencies, margins, and profit are added. They can also be added to each individual part (strictly speaking, contingencies are applied at the unit level and management reserves at the project level). The definition level is 90 – 100% and the accuracy of the estimate is 5 – 10%.
This type of estimate applies when costs are known. That is, the project has been tendered (not just designed) and quotes have been received. In that sense, it’s not really an estimate at all, however contract values can often change (at least in my industry!), extra work is added or work is changed, and generally speaking, stuff happens that results in the need to budget a value that is different than the sum of contractor quotes.
The lines between the estimates are sometimes grey, but they are not as grey as you would think at first glance. Order of Magnitude estimates are for planning, whereas Feasibility estimates are used for making a decision to proceed with the project. They sometimes have several options, but one of them must be to not proceed with the project at all. Preliminary estimates are mid-project and involve choosing between several options when the end product is not completely defined. Substantive estimates represent a well defined end product where the quantities of materials/resources are known. Finally, Definitive estimates represent knowing the costs, not just the quantities of materials/resources.
In addition, the process can skip backward if a decision cannot be made. For example, if the preliminary estimate is presented and the options are not satisfactory, the project could investigate other options that weren’t considered before and produce another feasibility estimate for those options.
In many industries the product is immediately well defined and you jump straight to substantive estimates – in this case you have probably never heard of the other kinds.
I will illustrate this process with an example.
- Five to ten years prior to construction, an Order of Magnitude estimate is developed to understand the scale of the expenditure.
- As the old factory is nearing capacity, a Feasibility estimate is produced, which the CEO uses to make the decision to proceed with the construction of a new factory.
- Six months later, the project team presents the CEO with several options for plant design and configuration, together with Preliminary estimates. Based on this estimate, one of the plant designs is chosen.
- One year later, the new factory has been designed, quantities of materials are known, and a Substantive estimate is presented prior to tendering for construction.
- Once the project has been tendered and construction is underway, a Definitive estimate is produced and/or updated as necessary.
Source of Data
In the project management profession, the following four techniques represent types of estimates based on where the data has been obtained.
- Expert Judgment
The best place to get project estimating data is from a technical subject matter expert. Of course, they would have the experience to tell what range the estimate should be, and provide excellent guidance to ensure each piece is estimated accurately. Unfortunately, experts are not always available, but in estimating you need to do everything you can to find them.
- Analogous estimating
This type of estimating involves comparisons to other, similar projects or project components. Most organizations perform projects that are similar to other projects within the organization, or know the costs of projects performed by other organizations. The actual costs can be scaled on the basis of known differences to arrive at the estimate for the new project
- Parametric estimating
This involves starting with a unit cost and scaling it up to the number of units required. Most industries have public knowledge banks that publish cost data, for example, the cost per square foot to build a house in various cities. The parametric value can also originate in-house, if many of those types of projects have been completed.
- Three point estimating
It is often intuitive to determine an optimistic and pessimistic value. Three point estimating uses those values to “skew” the estimate if there is higher upside or downside risk, or if the estimator wishes to introduce a skew to account for risk. The estimator chooses a Most Likely estimate (normal) as well as an Optimistic and Pessimistic value. These can be averaged using the triangular distribution:
Or if the intention is to keep the estimate tighter to the most likely value, the beta distribution can be used:
- a = Optimistic Estimate
- M = Most Likely Estimate
- b = Pessimistic Estimate
In addition, you can produce a project estimate based on top down or bottom up techniques.
- Top Down estimating
Often an estimate is determined at the project level (top) and apportioned (down) to the tasks. This can also occur with a portion of a project – you know what a certain project phase should cost so you can apportion it down into the individual tasks. Another common scenario is that the overall project estimate is raised or lowered, and the difference must be apportioned down into individual tasks. Regardless of the circumstance, the separation of an overall estimate into constituent pieces is called Top Down Estimating.
- Bottom Up estimating
This is usually how most project estimates start. The tasks are each estimated (bottom) and rolled (up) into the overall project estimate. Generally speaking, this is how must project estimates are constructed and justified.