#PM Cost Management—High-Level Overview of the Three Cost Management Processes


I originally was going to write an overview of the cost management process called Control Costs, but I decided to put it together with a review of the other two processes, Estimate Costs and Determine Budget, for reference.

1. Cost Management Processes Overview

Here’s a table giving a summary description of the three processes for an overview:

Figure 1. The Three Cost Management PM processes





Process Description
Planning 7.1 Estimate Costs Develops an approximation of the monetary resources needed to complete project activities..
7.2 Determine Budget Stage 1: Sums up the estimated costs to get the project estimate.

Stage 2: Reserves are added to get the cost baseline and the cost budget.

Stage 3: Periodic funding requirements are taken into account to get the final time-phased budget called the cost performance baseline.

Monitoring & Controlling 7.3 Control Costs Carry out the cost management plan.

Just a few words of clarification about the processes summarized in the paragraphs above.

7.1 Estimate Costs

There are two basic types of estimates: top-down (analogous and parametric) based on historical data of similar projects done in the past, and bottom-up methods (e.g., 3-point estimates) based on the WBS and risk analysis. Here are some points in distinguishing the various advantages and disadvantages top-down and bottom-up methods.

Figure 2. Comparison between Top-Down and Bottom-Up Estimates

Top-Down Bottom-Up
Time Quick Time-consuming
Range of Accuracy of Estimates Good for Rough Order of
Magnitude (ROM) Estimates

(-50%/+50% from actual costs)

Good for Budget Estimates (-10/25%)

If you add risk analysis, you can get Definitive Estimates (-5/+10%).

Project Type Best for projects similar to those done before. Best for research and development of new products.
Buy-In Good for management buy-in of project charter Good for buy-in of project team during planning

7.2 Determine Budget

The three stages I mention above are not mentioned in the PMBOK® Guide; they are my own labeling invention to make sense of the process. It was found in our study group that splitting the process into three stages made sense because it not only clarified the steps of the process, but it allowed grouping of the inputs, tools & techniques, and outputs of the process into more logical subgroups.

Stage 1

You add up all the activities to the level of the work packages, adding up all the work packages to the level of the control accounts, and then adding those up to get the final total: the project estimate, the sum of the direct costs of the project itself.

Note: There may be planning packages added if the project planning is using progressive elaboration. These are blocks of the WBS or work breakdown structure that don’t yet have a definitive estimate, usually in the later parts of the project. The project starts on the work that is detailed in the WBS for the first part of the project and which does have a definitive estimate. Then the planning packages are elaborated on and given those definitive estimates as the project gets closer to them. It’s like laying down the tracks for a train that is meanwhile coming down the tracks straight towards you.

Here’s a schematic for Stage 1 of the Estimate Costs process.

Figure 3. Stage 1 of the Estimate Costs Process

Stage 2

If there are project management costs that are not attributable to any one particular project, such as the costs of project management software tools (such as Microsoft Project), the company may decide to budget for these indirect costs by splitting them up in a specified way between the projects. If the company decides to do this, the indirect costs are added to the total direct costs, or project estimate, that was the end result of Stage 1.

Then two levels of reserves are added:

A. Contingency reserves

These are for risks accounted for in the risk register. They are added to the project estimate to get the cost baseline.

Project estimate + contingency reserves = cost baseline

Two things to note: a) contingency reserves can normally be used at the discretion of the project manager; b) the cost baseline is the basis for going on to Stage 3 of the process.

B. Management reserves

These are for unknown risks that are NOT accounted for in the risk register. They are added to the cost baseline to get the cost budget.

Cost baseline + management reserves = cost budget

Two things to note: a) management reserves, as the name implies, can normally only be used at the discretion of management, not the project manager; b) the cost budget is NOT the basis of carrying out the cost management plan, but rather the cost baseline is.

Below is a schematic that explains the process in Stage 2 of the Estimate Costs process.

Figure 4. Stage 2 of the Estimate Costs Process

Stage 3

The cost baseline is the total costs of the project plus the contingency reserves. Then the costs for the project are spread out across the schedule of the project to get the cost performance baseline. See the diagram below taken from the PMBOK® Guide.

If this amount cannot be 100% funded by the company at the beginning of the project due to cash flow constraints, then it must be funded periodically during the course of the project. In this case, the project funding requirements have to be set up at various points along the project.

The Determine Budget process is summarized graphically below.

7.3 Control Costs

Essentially the Control Costs process consists of carrying out the Cost Management Plan. Where does this come from? The planning for cost management does not take place in any of the cost management processes listed above; instead the cost management plan is created as a component of the overall project management plan in the process 4.2 Develop Project Management Plan which is part of the Integration Knowledge Area. The various elements of the Cost Management Plan are listed on my post for 10/14/2012.

Here are the various steps of the control costs process as listed in the PMBOK ® Guide, but let’s use the methodology of Six Sigma called DMAIC or Define-Measure-Analyze-Improve-Control, to group them logically. Six Sigma is normally used for managing quality of manufacturing processes, but the methodology can be considered analogous to the process of managing costs on a project.



Control Costs Process element

Stage 1. Define The cost performance plan is where the cost management processes are defined and the criteria set forth for controlling project costs.
Stage 2 Measure Monitoring cost performance (CV, CPI) and work performance (SV, SPI) to detect variances from cost performance baseline.

Monitoring cost expenditures (AC) so that they do not exceed periodic funding requirement limits.

Stage 3 Analyze Forecasting estimate at completion (EAC) and comparing to budget at completion (BAC) based on current trends.

Using To-Complete Performance Index or (TCPI) to calculate level of cost performance that needs to be achieved to bring EAC in line with BAC by the end of the project.

Determining the factors that create changes to the cost performance baseline.

Stage 4 Improve Corrective action to bring current cost overruns within acceptable limits. These actions can result in change requests, which are evaluated, approved/rejected, and implemented if approved.

Another type of change request is a change to the cost performance baseline if the current one is shown to be unrealistic.  

Stage 5 Control Preventive action to bring future costs overruns within acceptable limits—these can also result in change requests (see above under Improve).

In the next posts, I will go into the inputs, tools & techniques, and outputs of the Control Costs process using this five-stage description I have listed above.


#PM Cost Management—A Closer Look at the Outputs of the Determine Budget Process

1. Review: Three stages of the Determine Budget Process

The three stages of the Determine Budget Process are represented graphically below.

Fig. 1 Three Stages of the Determine Budget Process

There are three outputs from the Determine Budget Process.

1. Cost Performance Baseline

As a result of Stage 3 of the Determine Budget Process, the time-phased budget is created which shows how much of the budget is scheduled to be allocated at any point in time of the project. See diagram below, taken from Figure 7-6 in the PMBOK® Guide. T

The x-axis represents the point of time on the project schedule, and the y-axis represents the amount allocated in the budget cumulatively up to that point. For any point along the curve, the y-axis will give you the planned value or PV for that particular point in the project.  The rightmost point of the curve, at the point where the project is scheduled to end, is the Budget at Completion, or BAC.

2. Project Funding Requirements

In the above diagram, you also see the periodic funding requirements if the funding for the project is supplied in increments during the project rather than all at once at the beginning of the project. If there are such funding requirements, it is important that the project manager at any point in time on the project watches not only the actual costs versus the planned value (the point on the cost baseline curve that corresponds to that point in time on the project), but also what the periodic funding requirements are so that there the project’s costs don’t get too far “ahead of the curve”, which might cause further delays.

3. Project Document Updates

There will be updates to the following project documents:

Project Document Updates
1. Risk Register Contingency reserves
2. Cost Management Plan (part of Project Management Plan) Cost performance baseline (against which project performance will be measured and actions taken to control costs during the course of the project)
3. Project Schedule May have been altered due to funding limit reconciliation; usually results in longer schedule.

The Estimate Costs and the Determine Budget process are both in the Planning Process group. The next post will discuss this next process, which is the final cost management process, Control Costs, in the Monitoring & Controlling Process Group.

#PM Cost Management—A Closer Look at Tools & Techniques of the Determine Budget Process

1. Introduction: Three stages of the Determine Budget Process

As we discussed in the previous post, there are three stages of the determine budget process:

Stage 1: Getting the bottom-up estimate of the project by “rolling up” the estimates of the individual activities that make up each work package, and then summing up the work packages in each control account, and then summing up these control accounts to get the project estimate.

NOTE: If the only estimate of the project is a top-down estimate (analogous or parametric estimate), then this must be refined to the greatest extent possible. However, be aware that a bottom-up estimate is always going to be more accurate than a top-down estimate, so it is more preferable, albeit more time-consuming.

Stage 2. The project estimate contains all the direct costs of the project. Then the indirect costs of a project, that is, costs for project management that are shared between all projects (such as the cost of project management software, for example), are added to the direct costs. To this amount are added the contingency reserves to handle risks accounted for in the risk register. This result is the cost baseline, the one that the performance is measured against in earned value analysis during the course of the project. Then to the cost baseline are added the management reserves to handle risks NOT accounted for in the risk register. This results in the cost budget. The management reserves can be authorized only by management and not the project manager.

Stage 3. After “rolling up” the estimates to get the cost baseline, they are “rolled across” in terms of the schedule to get the final time-phased budget that is called the cost performance baseline.

The three stages are represented graphically below.

Fig. 1 Three Stages of the Determine Budget Process

2. Tools & Techniques of Determine Budget Process

I have listed the inputs to the Determine Budget process, but have organized them and color-coded them based on the scheme of the diagram above so that you can see what inputs are for which stage in the process.


Name of Tool or Technique

Used for …



Historical Relationships

Stage 1

If top-down estimates such as parametric or analogous estimates were used to get the project estimate, these are refined as much as possible with historical data from other projects, either from company data or published industry data. 


Cost Aggregation

Stage 1

Estimates for activities are “rolled up” into estimates for work packages , control accounts and the final project estimate. This is the heart of Stage 1 of the Determine Budget Process.


Expert Judgment

Stage 1

Experts could be those in the company with relevant experience on similar projects (for top-down estimates), or could be those who have experience determining the budget for previous projects (for bottom-up estimates).

 They could also be consultants or those in industry groups or professional associations that have knowledge of budgets of similar projects (for top-down estimates).


Reserve Analysis

Stage 2

This establishes the contingency reserves which are added to the project estimate to get the cost baseline, and the management reserves which are added on top of that to get the cost budget.


Funding Limit Reconciliation

Stage 3

The expenditures on the project for any given period (monthly, quarterly) should be reconciled with the available funding limits from the company for that period. If funds are not sufficient in any given period, the work schedule may have to be adjusted or reconciled with the funding limits available.

These tools & techniques are appropriate for the different stages of the process which are color-coded in a similar way to the diagram above.

The next post will cover the outputs to the Determine Budget Process.


#PM Cost Management—A Closer Look at the Inputs to the Determine Budget Process

1. Introduction

Yesterday’s post did a quick overview of the cost management process 7.1, Determine Budget, in terms of the following two stages.

Stage 1: The individual estimates for activities developed in the previous process Estimate Costs are summed up or “rolled up” to the level of work packages, control accounts, and then finally the project estimate.

Stage 2: The project estimate then adds indirect costs if that is required. Contingency reserves are then added for those risks on the risk register to get the cost baseline, which is what the performance of the project will be measured against using earned value an analysis. Management reserves are then added for those unknown risks which on not on the risk register, and this is the overall cost budget (project manager has authority to use contingency reserves; only management has authority to use management reserves).

However, there is an additional stage to the Determine Budget process:

Stage 3: Once the overall cost budget is available, then the budget has to be time-factored to account for the fact that the funding of the project may not be 100% available before the project starts, but rather may come available periodically during the course of the project. This cost restraint may cause additional time to be added to the schedule if funding for a certain portion of the project is not available by the date it was originally scheduled.

Fig. 1 Three Stages of the Determine Budget Process

Today’s post will take the inputs of the Determine Budget process and relate them to the various stages in the process referred to above.

2. Inputs to Determine Budget

I have listed the inputs to the Determine Budget process, but have organized them and color-coded them based on the scheme of the diagram above so that you can see what inputs are for which stage in the process.

Name of Input Used for … Explanation
1. Activity Cost Estimates Stage 1 Activity costs estimates are used to roll up into work packages.  (This is an output of process 7.1 Estimate Costs.) 
2. Scope Baseline (includes WBS) Stage 1 Work packages and control accounts are used to roll up into project budget.
3. Contracts Stage 1 Costs of work packages that are contracted out as procurements. 
4. Basis of Estimates Stage 2 (indirect costs) Indicates whether indirect costs are to be added after direct costs of project.  (This is an output of process 7.1 Estimate Costs.)
5. Organizational Process Assets Stage 2 (contingency reserves) Project document updates include risk register, which contains reserve analysis results from process 7.1 Estimate Costs.  (This is an output of process 7.1 Estimate Costs.)
6. Project Schedule Stage 3 Planned start and finish dates for activities, milestones, work packages, planning packages, and control accounts.
7. Resource Calendars Stage 3 Schedule of when resources are available during course of project schedule.

As you can see, some of the inputs (1, 4, and 5) come from the outputs of the cost management process 7.1 Estimate Costs, whereas the others come from the outputs of

  • scope management (input 2, Scope Baseline, comes from process 5.3 Create WBS)
  • time management (input 6, Project Schedule, comes from process 6.5 Develop Schedule)
  • human resource management (input 7, Resource Calendars, comes from process 9.2 Acquire Project Team)
  • procurements management (input 3, Contracts, comes from process 12.2 Conduct Procurements)

This shows how intricately interwoven the processes are from the different knowledge areas.

With these inputs, the Determine Budget process is conducted, which is the subject of the next post.

#PM Cost Management—An Overview of the Determine Budget Process

1. Introduction

There are three PM processes involved with cost management. Two of them, Estimate Costs and Determine Budget, are in the Planning Process Group, and Control Costs is in the Monitoring & Controlling Process Group.

As mentioned in a previous post, some of the planning for cost management takes place in the Develop Project Management Plan process under the Initiation Process Group. Here the Cost Management Plan is created as one of the subsidiary components of the overall Project Management Plan.





Process Description
Planning 7.1 Estimate Costs Developing an approximation of the monetary resources needed to complete project activities.
7.2 Determine Budget Sums up the estimated costs and add reserves to establish an authorized cost baseline.
Monitoring & Controlling 7.3 Control Costs Monitoring the status of the project to update project budget and manage changes to the cost baseline.

2.  Determine Budget

Once the estimates are created in process 7.1 Estimate Costs, the next process 7.2 Determine Budget aggregates or adds together all the costs associated with the project in two steps:

Step 1: Aggregation of the individual activity estimates of the WBS work packages.  These are “rolled up” using the WBS to form the aggregates of the work packages and the control accounts, the accounting placeholders in the WBS where you sum up the work packages beneath them.

(NOTE: Although the aggregation process talks about “rolling up” the estimates, in the schematic I have the arrow going downwards to show the flow of the process.)

Step 2: To the project estimate (direct costs), indirect costs may be added. Then contingency reserves are added for those risks listed in the risk register; these reserves are to be used during the project at the discretion of the project manager. This gives the cost baseline.

Management reserves are then added for all unknown risks (i.e., those not accounted for in the risk register), but this amount, as opposed to the contingency reserves, CANNOT be used by the project manager except with permission of the sponsor of the project. This final figure is the overall cost budget.

Once you understand this overall schematic of how costs are aggregated, then the next posts on the inputs, and the tools & techniques of the Determine Budget process will make more sense.

#PM Cost Management—A Closer Look at the Tools & Techniques of the Estimate Costs Process

1. Introduction

In yesterday’s post, I gave a breakdown of the various inputs to the Estimate Costs Process, organized by the type of the estimate they were to be used for. Today’s post is a breakdown of the various tools & techniques of the Estimate Costs Process given in the PMBOK® Guide, also organized by the type of estimate involved.

2. Accuracy vs. precision of estimates

Before I get to the accuracy of estimates, I realize that there may be confusion between accuracy and precision of estimates. In the cost management plan I summarized on 10/14/2012, I listed the first element out of six to be the units of measure and the level of accuracy of the estimates. This is a mistake; I should have said the precision of the estimates. I changed it in the table, but the mistake remains in the graphic.

So if I ended up forgetting the difference, I realized I need to make sure nobody reading my blog continues to make the same mistake. If you are firing at a target, the level of precision will mean how close the bullets will cluster together; the accuracy will mean how close the bullets get to the bullseye of the target. The cost management plan specifies the precision of the estimates, i.e., whether they will be rounded to the nearest $1,000, $100, or $10. The accuracy of the estimates specifies how far they end up being from the actual costs. One of the conceptual difficulties here is that you will not know the actual costs until the project is over. But you can zero in on them gradually in the course of the project in the following three stages, each of which reduces the range of the estimates:

Estimate type


When used

1. Rough Order of Magnitude (ROM) -50/+ 50% from actual Initiating process group
2. Budget -10/+25 from actual Planning process group
3. Determine -5 or -10/+10 from actual Executing process group

The Rough Order of Magnitude or ROM estimate is basically made to determine the feasibility of the project during the initiating process. For an ROM estimate, analogous, parametric, or other top-down estimates are most appropriate. It is called an ROM estimate because the upper end and lower end of the range differ by a total of 100%, or the same magnitude as the estimate itself.

The next stage, the Budget Estimate, reduces the range from -50/+50 to -10/+25, with the preference being for an overestimate rather than an underestimate to reduce the chance of an unwelcome “surprise” at the end of the project. The methods used for the Budget Estimate are those that are bottom-up estimates rather than the less accurate top-down estimates used to produce a ROM estimate.

The accuracy of the estimates can be further increased during the actual project itself because the uncertainty associated with various risks will gradually be reduced as the risk or opportunities either materialize or not. The range here can be reduced to -5 or -10/+10 from the actual costs. Reserve analysis and three-point estimates are risk-based tools and techniques used to refine the accuracy of the estimate during the executing process group.

3. Tools & Techniques of the Estimate Costs Process

The ninth entry, that of Project Management Estimating Software, is a tool of estimating; the rest can be considered techniques. I have grouped the techniques based on whether they are top-down, bottom-up, or risk-refined techniques.

Tool or Technique



1. Analogous estimates Top-down Uses overall costs based on actual costs of similar projects.
2. Parametric estimates Top-down Uses unit costs based on actual costs of similar projects.
3. Expert judgment Top-down or


  • Experts find historical information of company or industry to support top-down estimates.
  • Experts use information from previous projects to support bottom-up estimates.
4. Bottom-up estimates Bottom-up WBS is analyzed to determine more accurate estimates.
5. Cost of Quality Bottom-up\ Costs of quality such as

  • Prevention costs (quality assurance, training)
  • Appraisal costs (quality control)

are added to cost estimate.

6. Vendor bid analysis Bottom-up Costs for vendors contracted to supply deliverables are added to cost estimate.
7. Three-point estimates Risk-refined Costs of activities are given in terms of three estimates based on perceived risks and/or opportunities:

  • Most likely
  • Optimistic (best-case scenario)
  • Pessimistic (worst-case scenario)
8. Reserve analysis Risk-refined Contingency reserves are those additional costs incurred if certain risks in the risk register are triggered. These are added to project estimates to get the cost baseline.
9. PM Estimating Software Tool Spreadsheets, statistical tools, simulation tools are all used in obtaining estimates.

You can see by the nature of the techniques that the top-down techniques (analogous, parametric) are more useful for Rough Order of Magnitude estimates to be used in the Initiating process. The bottom-up techniques (based on an analysis of the WBS, plus the costs for quality and procurements) are more useful for the budget estimates to be used in the Planning Process. Although the risk-refined techniques (three-point estimates and reserve analysis) are started in the planning process, they are set up so that during the execution phase of the project, as certain risks either materialize or not, they can be used to refine the costs going forward so that they are useful for the definitive estimates of what the project will actually cost.

4. Summary

I hope that this organization of the various tools & techniques based on the general category of estimates has been useful.

I will not do a separate post on the outputs to the Estimate Costs process. This is because the next process in the Cost Management processes is that of Determine Budget, and the inputs to that process will include the outputs of the Estimate Costs Process.

#PM Cost Management—A Closer Look at the Inputs to the Estimate Costs Process

This post is a closer look at the Inputs to the Estimate Costs Process, and categorizes them according to the particular estimating tools & techniques they will be used for in the process.

1. Introduction

There are six inputs to the Cost Management Process 7.1: Estimate Costs. They come from the Scope Knowledge Area (Scope Baseline), the Time Knowledge Area (Schedule), Human Resources Area (HR Plan), and the Risk Knowledge Area (Risk Register), as well as the all-purpose inputs from Enterprise Environmental Factors (EEF) and Organizational Process Assets (OPA).

Here’s a description of the Inputs to the Estimate Costs.

Inputs How used in Estimate Costs Process
1. Scope baseline (= Scope Statement, WBS, WBS dictionary)
  • Scope Statement contains assumptions on whether estimates include direct project costs only or indirect project costs as well.
  • Scope Statement contains list of constraints, including budget constraints.
  • WBS dictionary contains detailed description of work used to produce deliverables, which is helpful in bottom-up estimates.
2. Project Schedule Activity duration estimates and activity resources estimates are crucial for bottom-up cost estimates.
3. Human Resources Plan This will give info on manpower resource estimates and will give estimates on costs of reward/recognition programs.
4. Risk Register This will assist in creating three-point estimates and reserve analysis.
5. Enterprise Environmental Factors (EEF) Historical information from the marker and published commercial information will be helpful for parametric estimating and analogous estimating.
6. Organizational Process Assets (OPA) Information from previous projects done by the organization will be helpful for parametric and analogous estimating.

There are three orders of refinement of a cost estimate. A top-down estimate is used for a rough estimate, and then a budget estimate is produced with a bottom-up estimate. The accuracy of this is further refined by 3-Point Estimates into a Definitive Estimate.

Note the different inputs that are generally used for each type of estimate below.

The next post will go through the different tools and techniques of cost estimating to compare and contrast them. They also will show the intersection between the cost management knowledge area and the other knowledge areas of the project management process matrix.

#PM Cost Management–Cost Management Plan

1. Introduction—

Let’s start the topic off with a quiz. Under which cost management process is the cost management plan developed:

  1. Estimate Costs
  2. Determine Budget
  3. Control Costs
  4. None of the above

The surprising answer is: D, none of the above. The cost management plan is actually developed as part of the overall project management plan in the integration knowledge area process 4.2 Develop Project Management Plan. So the very first cost management process, 7.1 Estimate Costs, already assumes that the cost management plan has been completed.

2. Purpose

If you give the simple answer to “what is the purpose of the cost management plan” as being “to manage the costs”, you would be right. However, if you were asked to explain your answer, you’d need a little more detail. “Manage costs” really has to do with being able to monitor and control them, where the word “monitor” means “measure.” Here are the components of the cost management plan divided into those elements which are more for monitoring or measuring the costs (those in shades of red), and those which are more for controlling the costs (those in shades of blue).

Here are the descriptions of the elements:

Plan Element

Monitoring or Controlling


1. Units of measure, level of precision Monitoring Are the costs computed in staff hours or days?  What is the level of rounding of the data?
2. WBS & Control Accounts Monitoring WBS has control accounts, where the costs of the WBS elements below it are summed up.
3. Reporting Formats Monitoring Who will get the cost performance reports, and how often?
4. Performance measurement rules Controlling The earned value measurement techniques are specified (i.e., using what formulas, or what percent complete).
5. Control thresholds Controlling Cost control thresholds are the percentage that the costs are allowed to vary from the cost baseline. Actions to be taken are specified in case the cost variance exceeds the cost control threshold.
6 Change control procedures Controlling If the cost baseline itself needs to be changed, the change control procedure is specified.

Here are a few additional remarks about these elements. First let’s discuss those that have to do with monitoring or measuring the costs. These three elements are fairly independent of each other.

1.  Units of measure, level of accuracy

The units of measure may refer to the unit costs (cost per staff hour, for example), or possibly the unit of currency in an international project. The level of accuracy refers to the level of precision in stating each cost. There is a concept having to do with the level of accuracy of the cost estimates, but this has more to do with the process 7.1 Estimate Costs.

2. WBS & Control Accounts

The control accounts are different from other elements below in the WBS in that they do not specify deliverables. They are there for accounting purposes to alert the project manager that, when the activities in the WBS elements below it are completed, the costs for those activities needed to be summed up and reported. Each control account is assigned a unique code or account number for accounting purposes.’

3. Reporting Formats

Once the costs are calculated and the performance measurement calculations are done, who gets the report and how often? This element is pretty straightforward.

Now let’s move on to the elements that have to do with controlling costs. As opposed to the elements involved in monitoring costs, these three elements are actually closely related and should be understood in the following sequence.

4. Performance measurement rules

Okay, this is the heart of controlling the costs; comparing the measured or monitored actual costs and comparing them to the budgeted or estimated costs. How much do they vary?

5. Control thresholds

Similar to control thresholds in quality, but with cost being the operative measurement here, there are specifications for how far the actual costs are to vary from the budgeted costs, usually in terms of a percentage. Then various thresholds are established so that if the variance goes over, say, 5%, the project manager must assemble the team and look for a root cause. If it is more than 10%, management may need to be informed. (These are just examples.)

6. Change control procedures

If the control thresholds are triggered, there will have to be some investigation and possibly a recommendation for a change. It could be in the form of a corrective action, in which there is a change control procedure specified for that scenario. But if the investigation reveals that the estimated costs were based on unrealistic assumptions, the cost performance baseline (i.e., the budget) may need to be changed. This will definitely involve the sponsors and/or customers, and this scenario needs to be covered by the change control procedures as well.

Note that the cost management plan doesn’t tell you how to move towards getting the budget. It only tells you how to monitor and control the costs AFTER you have estimated them. And that is the subject of the next post, the process 7.1 Estimate Costs.

#PM Cost Management—Cost Risk

Cost risk is a concept of the cost management knowledge area that touches upon the knowledge areas of risk and procurements. This is because it refers to which party, the buyer or the seller, is at risk of bearing the additional costs if the cost of the goods or services ends up being more than the amount agreed upon in the procurement contract.

Here’s a chart comparing the three main types of procurement contracts:

Procurement Contract Explanation Cost risk Main use
1. Fixed Price (FP) Buyer pays seller a fixed price for producing goods or services Seller Well-defined scope and resource requirements
2. Time and material (T&M) Buyer pays seller on a per-hour or per-item basis Seller/Buyer Scope defined, but resource requirements uncertain
3. Cost reimbursable (CR) Buyer pays seller costs incurred for producing goods or services Buyer Scope uncertain

Here’s an explanation of why the cost risk is listed as in the above chart:

1. Fixed Price (FP)

Let’s take an example of a fixed price contract where the buyer agrees to pay the seller $5000 for producing a component that the buyer needs to put in the product it is manufacturing. If the actual costs for the seller producing the component end up being $6000, and the seller is still paid only $5,000 by the buyer, this means the seller loses $1,000 in profit on the contract.

So the seller will usually want to see the scope defined in the statement of work to be as clearly defined as possible, and the resource requirements to also be clear to the seller in order to control the cost risk. In this way, the seller will know whether the company can produce the goods or services for a profit or not.

2. Time and material (T&M)

Here the cost risk is somewhere in between that of a fixed price and cost reimbursable contract because the price per hour or per item is fixed, but the amount of resources required from the seller is unknown. The buyer will want to put limits ahead of time on the amount of hours or items it will agree to pay for in order to limit its cost risk.

3. Cost reimbursable (CR)

If the scope is uncertain, especially in cases where the buyer is creating some new product it has never produced before, the cost reimbursable contract is probably the type the seller would prefer because if the costs end up being higher than anticipated, the buyer will pay for those additional costs. Here it is the buyer who will want to define in the contract as clearly as possible what the allowable reimbursable costs are in order to control the cost risk.

Because of the asymmetrical risk between the buyer and seller, they can end up working at cross purposes. Therefore, there are systems of incentives which can be added to the basic contract types in order to make the interests of the buyer and the seller more nearly coincide. The details of these subtypes of contract under the three basic types listed above will be taken up in the posts on the Procurement knowledge area.

The next post will deal with the elements of the cost management plan.

#PM Cost Management—Life Cycle Costing

This is a continuance of my review of the topics of project management covered in our study group.   Although I passed the project management examination last Tuesday, our study group is reconvening so I can work on getting the other members to pass the test.    This next series of posts is on the cost management area of the PMBOK Guide.

Many of the concepts in the cost management area actually touch upon other knowledge areas as well. One such concept is that of “life cycle costing”, which borders on the quality knowledge area.

The idea of life cycle costing is that if your project is developing a product, you need to consider the entire life cycle of the product including the costs of repair when you estimate the costs of quality.

Here’s how it works:

The cost of quality (aka the cost of conformance) is made up of two parts:

1. Prevention Costs

The cost of preventing defects are prevention costs, examples of which are the quality planning process itself (including all the associated documentation), training of the team in quality methods (such as Six Sigma), and the Quality Assurance or quality audit process to make sure the correct quality processes developed during the quality plan are being carried out by the now-trained team.

2. Appraisal Costs

The cost of controlling and monitoring for defects are appraisal costs (think inspection), examples of which are the costs of the quality control process, including the cost, manpower, time and equipment used to do the testing and to analyze the results.

Fig. 1 Cost of Quality or Cost of Conformance

Someone may have the bright idea of reducing the level of quality to reduce these costs, because that will reduce the project costs. This may have the unintended consequence of raising other costs associated with that project. These are the costs of nonconformance, or the costs of poor quality, which also consist of two parts.

3. Internal Failures

What if defects are not prevented? Then if they are detected on the assembly line, these defective parts either have to be scrapped or reworked, which may adversely affect the company’s just-in-time inventory system, on top of the cost of repairing or replacing these parts. The defects have to be tracked and analyzed for the cause of the defect, and this tracking system adds costs as well.

4. External Failures

Even more serious than the internal failure costs, are the costs if the defects are produced and undetected on the assembly line. These get shipped out the door to customers, and become external failures. The customer will want to get the goods returned or repaired under warranty. However, if the failure is of a more serious nature that the customer becomes injured, then the costs escalate if a product liability claim or lawsuit is brought against the company. Customer satisfaction is adversely impacted, and the costs of the help desk or customer service department are increased.

Fig. 2 Cost of Poor Quality or Cost of Nonconformance

Now it is possible that the cost of getting to a certain level of quality may be higher than the cost saved in terms of internal failures or external failures. However, the calculation of life cycle costs of quality has to include all four of these categories. You should not lower the cost of quality on your project at the expense of the increased costs to the company on the overall life cycle costs of the product that is the result of your project.

Tomorrow, I will talk about another cost management area that happens to touch upon other knowledge area: cost risk, that is, cost-related risk involving procurements.