Day 2: Detailed Study of Cost Estimation Techniques: Analogies and Parametric

Day 2: Detailed Study of Cost Estimation Techniques: Analogies and Parametric

I. Introduction

Welcome to Day 2 of Week 2 in our exploration of Cost Estimation Techniques. Today, we are going to delve deeper into two specific techniques: analogous estimating and parametric estimating.

Brief Recap of Previous Session’s Learnings

Yesterday, we introduced the concept of project cost estimation. We explored why accurate cost estimation is pivotal in the success of any project. We discussed the different types of costs that can be included in a project’s budget, such as direct costs, indirect costs, fixed costs, and variable costs. We also talked about how uncertainty and risk can impact the cost of a project and why contingency reserves are necessary.

Learning Objectives of the Current Session

The objective of today’s session is to gain a solid understanding of two cost estimation techniques: analogous and parametric estimating. By the end of this session, you will be able to:

Define and explain the concepts of analogous and parametric estimating.
Discuss the pros and cons of each technique.
Understand the differences and the applicability of each technique in real-world scenarios.
Apply these techniques to provided scenarios for practical understanding.

Explanation of the Day’s Agenda

Today’s session is divided into several segments:

Analogous Estimating: We will define this technique and provide examples. We will then discuss its advantages and disadvantages.
Parametric Estimating: Similarly, we will define parametric estimating, provide examples, and discuss its pros and cons.
Comparing the Techniques: We will compare and contrast these two techniques, discussing when it’s best to use one over the other.
Hands-On Practice: You will get a chance to apply these techniques to realistic project scenarios. This will help cement your understanding and give you some practical experience.
Summary and Concluding Notes: We will conclude the day by summarizing the key points and providing you with some additional resources for further study.

We look forward to this journey with you as we explore these two cost estimation techniques, helping you gain a solid understanding of how and when to apply each in your future or current project management roles.

II. Cost Estimation Techniques Overview

Before we delve into the specifics of analogous and parametric estimating, let’s first provide a brief overview of cost estimation techniques in general, their importance, and the key differences among the various techniques.

What Are Cost Estimation Techniques?

Cost estimation techniques are the methods and procedures used to forecast the costs of a project. These techniques are based on analyzing historical data and current market conditions to predict future costs. They are integral to successful project management because they help to establish a project’s budget and measure the project’s performance against that budget.

Cost estimation techniques fall into two broad categories:

Qualitative Techniques: These are based on the judgement and experience of project managers and subject matter experts. An example is expert judgement technique.
Quantitative Techniques: These are based on the analysis of detailed data. Examples include parametric estimating, three-point estimating, and analogous estimating.

Importance of Cost Estimation Techniques

Cost estimation techniques are vital for several reasons:

Budgeting: They help to establish the project budget by predicting the cost of project activities.
Risk Management: They help identify potential financial risks. If the estimated costs are significantly higher than the available budget, the project may not be feasible.
Decision Making: Cost estimates can influence the decision-making process at various stages of the project. For example, choosing between different project approaches or determining whether to outsource certain activities.
Performance Measurement: Cost estimates provide a baseline against which to measure the project’s performance.

Differences Between the Various Cost Estimation Techniques

Each cost estimation technique has its unique approach, with some being more suitable for certain situations than others:

Analogous Estimating: This is a top-down approach that estimates the cost of the project based on the cost of similar past projects. It’s less accurate but fast and easy to apply, especially when there is limited project information available.
Parametric Estimating: This is a statistical technique that uses historical data and mathematical relationships between variables. It’s more accurate than analogous estimating but requires more detailed and accurate data.
Three-Point Estimating: This technique takes into account the uncertainty in cost estimation by using three estimates: most likely, optimistic, and pessimistic. It’s more complex and time-consuming but can provide a more realistic cost range.
Expert Judgement: As the name suggests, this technique relies on the experience and knowledge of experts in the field. It can be highly accurate if the experts have a deep understanding of the project, but it can also be subjective.
Bottom-Up Estimating: This involves estimating the cost of individual activities or work packages and then adding them up to get the total project cost. It’s the most accurate but also the most time-consuming method.

In the next segments, we’ll go into more detail on the first two techniques – analogous and parametric estimating.

III. Analogous Estimating

Definition and Examples of Analogous Estimating

Analogous estimating, also known as top-down estimating or historical data estimating, is a technique for estimating the cost of a project (or parts of a project) based on the costs of similar, past projects. For instance, if a past software development project cost $10,000 and took a month to complete, you might estimate that a similar future project will have a comparable cost and duration.

This technique is most reliable when the previous projects are similar in fact, not just in appearance, and the individuals preparing the estimates have the expertise to factor in the differences between the projects.

Pros and Cons of Analogous Estimating

As with any technique, analogous estimating comes with its pros and cons.

Pros:

It is quicker and less costly than other methods.
It is useful when there is limited information about the project.
It can be applied to a total project or to specific tasks or components.

Cons:

It is less accurate than other methods, especially if the previous projects are not truly comparable.
It depends heavily on the expertise of the person making the estimate.
It may not account for differences in project conditions, such as location, resources, or time.

Case Study Demonstrating the Use of Analogous Estimating

Consider an IT company that regularly installs server systems for various businesses. Over time, they’ve found that a standard server installation typically costs around $5,000. When approached by a new client for a similar installation, they can use analogous estimating to predict that the new project will also cost around $5,000. This estimate can then be refined based on any unique characteristics of the new project.

Knowledge Check: Multiple Choice Questions to Assess Understanding

Analogous estimating is also known as…
a) Bottom-up estimating
b) Expert judgment estimating
c) Top-down estimating
d) Parametric estimating
Analogous estimating is most effective when…
a) The previous projects are similar in fact, not just in appearance
b) There is a large amount of detailed data available
c) The project is large and complex
d) The project is unique with no similar past projects
Which of the following is NOT a limitation of analogous estimating?
a) It may not account for differences in project conditions
b) It is less accurate than other methods
c) It is time-consuming and costly
d) It depends heavily on the expertise of the person making the estimate

(Answers: 1-c, 2-a, 3-c)

In the next segment, we’ll explore another cost estimation technique – parametric estimating.

IV. Parametric Estimating

Definition and Examples of Parametric Estimating

Parametric estimating is a quantitative cost estimating technique that uses statistical modeling to determine a project’s costs. This technique involves using historical data of key cost drivers to calculate an estimate for project costs.

For example, a construction company may have historical data showing that the cost of building a commercial property is $150 per square foot. If the company is tasked with building a 10,000 square foot property, they can use parametric estimating to predict that the project will cost $1,500,000 (10,000 sq ft * $150/sq ft).

How Parametric Estimating Is Different from Analogous Estimating

While both techniques rely on historical data, they differ in precision and applicability:

Precision: Parametric estimating typically provides more accurate results than analogous estimating as it’s based on mathematical calculations using specific project parameters.
Applicability: Analogous estimating is often used when there is limited information about the project, whereas parametric estimating requires detailed, high-quality data to be effective.

Steps to Create a Parametric Estimate

Identify Parameters: Determine the project variables that will impact the cost. In our example above, the parameter was square footage.
Collect Data: Gather historical data for the identified parameters. This data should ideally come from similar projects.
Establish a Cost-Parameter Relationship: Determine how costs relate to the identified parameters. This could be as simple as a unit cost or as complex as a mathematical formula.
Calculate the Estimate: Use the cost-parameter relationship to calculate the project cost estimate.

Pros and Cons of Parametric Estimating

Pros:

It can provide more accurate estimates, assuming the underlying data is of high quality.
The estimates are quantitative and based on specific project parameters.
It can be scaled to different sized projects by simply changing the parameters.

Cons:

It requires detailed and high-quality data, which may not always be available.
It may not account for unique project circumstances that can impact costs.
It assumes a constant relationship between the cost and the parameter, which may not always hold true.

Case Study Demonstrating the Use of Parametric Estimating

A software company is contracted to develop a web application. They have historical data indicating that it costs around $5,000 to develop each web page. Given the client’s specifications, the application will require around 20 pages. Using parametric estimating, the company estimates that the project will cost around $100,000 (20 pages * $5,000/page).

Knowledge Check: Multiple Choice Questions to Assess Understanding

Parametric estimating is most effective when…
a) There is little to no information about the project
b) Detailed and high-quality data is available
c) There are no similar past projects
d) The project is small and simple
Parametric estimating differs from analogous estimating in that it…
a) Is less accurate
b) Is based on expert judgment
c) Requires more detailed data
d) Is always faster to perform
Which of the following is NOT a step in creating a parametric estimate?
a) Identifying parameters
b) Collecting data
c) Establishing a cost-parameter relationship
d) Performing a risk analysis

(Answers: 1-b, 2-c, 3-d)

In the next segment, we’ll compare these two techniques and discuss when to use one over the other.

V. Differences and When to Use Each

Comparison of Analogous and Parametric Estimating

While both analogous and parametric estimating are valuable tools in the project manager’s toolkit, they differ in several important ways:

Data Requirement: Analogous estimating is typically used when there is limited data about the project, while parametric estimating requires detailed and high-quality data.
Accuracy: Parametric estimating usually provides more accurate results than analogous estimating, assuming the underlying data is reliable.
Time and Cost: Analogous estimating is quicker and less costly, as it does not require extensive data analysis. On the other hand, parametric estimating can be more time-consuming and expensive due to the need for detailed data collection and analysis.
Scalability: Parametric estimating is more scalable as it can be applied to projects of different sizes by simply adjusting the parameters.

Situational Usage: When to Use Analogous vs Parametric Estimating

The choice between analogous and parametric estimating often depends on the specific circumstances of the project:

Use Analogous Estimating when there is limited information about the project, the project is similar to past projects, or when quick and cost-effective estimates are needed. This method is often used in the early stages of a project, when detailed information may not yet be available.
Use Parametric Estimating when there is detailed, high-quality data available, and accuracy is more important than speed or cost. This method is particularly useful for larger or more complex projects where costs can be more accurately determined by breaking the project down into smaller, measurable units.

A Real-World Example Showcasing the Selection between Analogous and Parametric

Imagine a construction company is tasked with building a unique, state-of-the-art facility. They’ve built similar facilities in the past, but the unique design elements in this project make it hard to directly compare with previous projects.

In the early stages of the project, they may use analogous estimating to provide a rough estimate of the project’s cost. This estimate can be used for initial budgeting and planning purposes.

However, as they begin to gather more detailed information about the project (e.g., architectural plans, material requirements), they can switch to parametric estimating. They can use their detailed data on the cost of materials and labor, along with the specific requirements of the project, to provide a more accurate cost estimate.

In this scenario, the company has wisely used both estimating techniques at different stages of the project, leveraging the strengths of each method as the project progresses.

VI. Hands-On Practice

Practice Problem

Now it’s time for you to put what you’ve learned into practice. Here’s a scenario for you to work on:

You’ve been tasked with organizing a series of seminars for a corporate training event. The last event you organized was similar in scope and cost $20,000. However, for this event, the client wants to increase the number of seminars from 10 to 15.

Use both the analogous and parametric estimating techniques to estimate the cost of this project.

Solution

Analogous Estimating: The last event cost $20,000. Since the new event is similar, you might initially estimate that the cost will be roughly the same. However, keep in mind that the client wants to increase the number of seminars, so the cost is likely to be higher.
Parametric Estimating: For this technique, we need more detailed data. Assuming each seminar was equally expensive in the last event, we can calculate the cost per seminar: $20,000 / 10 = $2,000 per seminar. For the new event, with 15 seminars, the total cost estimate would be $2,000 * 15 = $30,000.

Discussion of Common Errors

One common mistake is not considering the full scope of changes between projects. In this scenario, the increased number of seminars significantly impacts the cost. A simple analogous estimate without considering this change would lead to an underestimation of the cost.

Another common error is not considering the quality of the data used. For the parametric estimate, we assumed that each seminar cost the same amount. However, if some seminars were more expensive due to higher-priced speakers or more expensive materials, our parametric estimate might be off.

Always remember: your estimates are only as good as the data they’re based on. It’s essential to consider all relevant factors and to use high-quality, detailed data whenever possible.

Additional Learning Resources

If you’re interested in diving deeper into cost estimation techniques and project cost management, here are some recommended resources:

Books:

Project Management: A Systems Approach to Planning, Scheduling, and Controlling by Harold R. Kerzner – This comprehensive book covers all aspects of project management, including cost estimation techniques.
Project Estimating and Cost Management by Parviz F. Rad – This book provides detailed discussions of project cost management and estimation techniques.
A Guide to the Project Management Body of Knowledge (PMBOK Guide) – This is the definitive guide for project management professionals and includes a wealth of information on cost management.

Articles:

Cost Estimation for Projects: How to Estimate Accurately by Elizabeth Harrin (Read here)
Different Types of Cost Estimation in Project Management by Eileen O’Loughlin (Read here)

Videos:

Project Cost Management – Estimation Techniques by iZenBridge Consultancy Pvt Ltd (Watch here)
Cost Estimating Techniques by Engineer4Free (Watch here)