Case: Bull AS

In the company Bull AS, a product development project is being initiated. To account for the uncertainty associated with project costs, a simulation has been conducted to calculate the need for project reserves. The company’s management has decided to set aside a reserve of $1 million, which provides only a 15 percent probability of cost overrun.

The decision was made not to split the reserve into an unspecified post and an unforeseen post. Because of concerns about the project manager’s use of the reserve, it was also decided that the project’s steering committee would control 1/6 of the reserve, the line organization 2/6, and the project owner 3/6. The project manager had no control over the allocated reserve. However, a rule was established stating that whenever a need arose, the project manager was authorized to use up to $50.000 of reserves controlled by the steering committee. If there was a need for an amount exceeding $50,000, an application had to be presented to the steering committee. Once the reserve controlled by the steering committee was depleted, the reserve controlled by the line organization and then the reserve controlled by the project owner would be transferred to the steering committee.

Discuss the unfortunate consequences this system of project reserve control could create for the project manager.

The system for controlling the project reserve in Bull AS could create several unfortunate consequences for the project manager:

Limited authority and flexibility: The project manager does not have any direct control over the allocated reserve. This restricts the project manager’s ability to manage unforeseen costs or needs that arise during the project. The project manager always has to seek approval from the steering committee to use the reserve, unless the amount is under $50,000. This can lead to project delays and inhibit quick response to changes or problems.

Lack of responsibility: By distributing control of the reserve among various parties (the steering committee, line organization, and project owner), ambiguities and a lack of responsibility could arise. If the project manager needs to use more than $50,000 from the reserve, an application must be submitted to the steering group. This can lead to bureaucracy and delays in the decision-making process, especially if the steering group is not available or cannot convene quickly to assess the application.

Resource allocation and prioritization: When the reserve of the steering committee is depleted, the reserve controlled by the line organization and project owner must be transferred to the steering committee. This can create conflict and uncertainty around resource allocation and priorities in the project. The project manager might find that necessary funds are being moved to other parts of the organization, which could affect the project’s success and ability to handle unforeseen challenges.

Limited learning and improvement: By not giving the project manager control over the reserve, the opportunity to learn from the project manager’s decisions and experiences with resource management is lost. The project manager has first-hand knowledge about the project’s needs and challenges, and by limiting their authority, valuable insights and the chance to improve future projects may be missed.

In summary, this system of project reserve control could result in limited freedom of action and flexibility for the project manager, as well as create uncertainty, conflict, and bureaucracy. It could hinder the project’s ability to adapt to changes and handle unforeseen events effectively.

Discuss why accuracy in cost estimation is so important, yet so difficult.

Accuracy in cost estimation is very important for several reasons:

  • Resource allocation: Accurate cost estimation is necessary to ensure adequate resource allocation to the project. By having a good understanding of the expected costs, one can ensure that sufficient funds and resources are available to complete the project without delays or interruptions.
  • Decision making: Cost estimates play an important role in decision-making related to the implementation of a project. For example, cost estimates can help management assess the project’s profitability and viability. It can also assist the project manager in evaluating different alternatives and making informed decisions to optimize costs and resource usage.
  • Budget management: An accurate cost estimate is crucial for effective budget management. By having a realistic overview of the costs, one can establish an appropriate budget, monitor expenses during the project, and make necessary adjustments to avoid cost overruns.
  • Customer and stakeholder expectations: Cost estimates also influence customer and stakeholder expectations. By providing realistic estimates, one can create trust and credibility with customers and other stakeholders. Inaccurate or misleading estimates can lead to dissatisfaction, loss of trust, and a negative impact on the reputation of the project and the organization.

On the other hand, cost estimation is a challenging task for several reasons:

  • Uncertainty: Projects often involve uncertainty, and it can be difficult to predict all factors that may affect costs. There can be changes in requirements, complexity, unforeseen events, or external factors such as economic changes. This uncertainty makes it hard to create accurate estimates.
  • Lack of data and experience: In many cases, there may be limited access to previous data or experiences that can be used as a basis for cost estimation. If the project is unique or innovative, there may be a lack of relevant references or historical data that can be used to inform the estimates.
  • Complexity: Projects can be complex with many variables and dependencies. Accounting for all these factors and their impact on costs can be a challenging task. Lack of understanding or overview of the project’s scope and details can lead to inaccurate estimates.
  • Human factors: Estimation is a task that involves human judgment and discretion. Different individuals may have different perspectives, levels of knowledge, and experiences that can affect the estimates. Errors or biases in judgment can lead to inaccurate estimates.

In summary, accuracy in cost estimation is important to ensure effective resource allocation, decision making, budget management, and customer/stakeholder expectations. However, achieving accuracy is difficult due to uncertainty, lack of data, complexity, and human factors that influence the estimation process. It therefore requires thorough analysis, experience-based insight, and the use of appropriate methods and tools to reduce the margin of error and increase the accuracy of cost estimates.

Assume that a budget is to be prepared for a project. Discuss the differences between the use of a top-down estimation principle and a bottom-up estimation principle.

When it comes to preparing a project budget, there are two common approaches to cost estimation: the top-down estimation principle and the bottom-up estimation principle. Here are the differences between these two approaches:

Top-down Estimation Principle: Top-down estimation involves starting with an overarching, general cost framework and then allocating costs down to the various project activities or work packages. This principle is based on a rough and overarching approach, where costs are estimated at a high level of the project structure. Some of the characteristics of top-down estimation include:

  • High level of uncertainty: The cost framework is based on general assumptions, historical data, or experiences from similar projects. There is limited detail and specificity in the cost estimates.
  • Quick and efficient: Top-down estimation can be faster and more efficient in the early stages of the project. It provides a quick overview of project costs and helps to assess the project’s viability.
  • Potential over- or underestimation: Since estimates are based on general assumptions, there is a greater risk of over- or underestimating costs. It can be challenging to identify specific cost drivers or unique needs at an overarching level.

Bottom-up Estimation Principle: Bottom-up estimation takes a more detailed approach by estimating the costs for each individual activity, work package, or task in the project and then summing them up to form the total budget. Some of the characteristics of bottom-up estimation include:

  • High level of detail and accuracy: Bottom-up estimation requires a thorough analysis and breakdown of the project into smaller parts. Costs are estimated at a detailed level, and it takes into account specific activities, resource needs, and timelines.
  • More accurate and reliable: By estimating the costs for each individual component, one gets a more accurate and reliable overview of the project’s costs. It provides better insight into cost drivers and the opportunity to identify potential risks and challenges.
  • Time and resource intensive: Bottom-up estimation can be more time-consuming and resource-intensive, especially for large and complex projects. It requires thorough analysis, involvement of subject matter experts, and detailed planning.

A common approach is to combine the top-down and bottom-up estimation principles. One can use top-down estimation in the early stages of the project to get a rough overview of costs and assess the project’s viability. Then one can use bottom-up estimation to get a more accurate and detailed cost calculation when the project is better defined.

By combining these two approaches, one can take advantage of both a quick overview and more precise cost control. It is important to note that the choice of estimation principle depends on the project’s characteristics, complexity, availability of data and information, and time and resource constraints.

The challenge leaders often face when deciding whether to implement a project is the accuracy of the budget. Often, there is a great deal of uncertainty associated with the figures they are presented with. Discuss what can be done to ensure that decision-makers have the greatest possible confidence in the budget figures.

To ensure that decision-makers have the greatest possible confidence in budget figures, the following measures and best practices can be considered:

Fundamental process for cost estimation: It is important to have a thorough and structured process for cost estimation. This can include careful review of the project’s scope, identification of all relevant cost drivers, and involvement of key stakeholders and experts to ensure a comprehensive assessment of costs.

Gathering of relevant and reliable information: Collecting relevant and reliable information is crucial for accurate cost estimates. This can include using historical data from previous projects, using industry standards, or consulting with experts to gain insight and knowledge about the costs associated with similar projects.

Use of multi-dimensional estimates: It can be helpful to use various methods and approaches for cost estimation. This can include top-down and bottom-up estimation, use of analogy (comparison with previous projects), and parametric estimation (based on specific parameters and variables). By using multiple methods, one can obtain a more balanced and reliable estimate.

Uncertainty assessment: Including a thorough assessment of uncertainty associated with cost estimates is important. Identifying potential uncertainties and their impact on costs can contribute to a more realistic assessment of the budget. This can be done through uncertainty analyses, simulations, or the use of contingency reserves to account for unforeseen costs.

Transparent communication: It is important to maintain open and transparent communication about cost estimates. Decision-makers should be involved in the process and have the opportunity to provide input and ask questions. The presentation of the budget should be clear, with clear explanations of assumptions, methods, and any limitations. Any uncertainty factors should also be clearly communicated.

Continuous monitoring and updating: The budget should not be viewed as a static document but as a dynamic tool. It is important to implement an effective monitoring and reporting process to keep track of costs in the project and update the budget when changes or unforeseen events occur. This helps to maintain trust and ensure that the budget is up-to-date and relevant throughout the project’s lifespan.

By implementing these measures, decision-makers can have greater confidence in the budget figures and make more informed decisions about project implementation. It is important to remember that even with all these measures in place, there will always be a certain degree of uncertainty and the need for adjustments during the project.

Discuss the dangers involved in uncritical use of experience figures from other projects when preparing a budget for a new project.

Uncritical use of experience figures from other projects can be problematic and entail several dangers when preparing a budget for a new project. Here are some of the potential hazards:

  • Contextual difference: Each project is unique and has different contextual factors that influence costs. Using experience figures from other projects without taking these differences into account can lead to inaccurate estimates. Factors such as the project’s scope, complexity, geographic location, timing, and technological requirements can vary significantly, and this can affect costs.
  • Selective memory and bias: When relying on experience figures from previous projects, there is a risk of selective memory and bias. Past success stories can capture attention, and one might overlook or undercommunicate past projects’ errors and problems. This can lead to over-optimistic estimates and underestimation of actual costs.
  • Lack of updating: Experience figures from past projects can become outdated over time due to changes in technology, prices, the market, or other factors. Relying on outdated experience figures can lead to incorrect estimates and thus potential cost overruns in the new project.
  • Variation in data quality: The quality of available data from previous projects can vary significantly. Some projects may have thorough and accurate cost data, while others may have incomplete or unreliable data. Relying on poor quality data can lead to incorrect estimates and uncertainty around the budget.
  • Lack of flexibility: Only relying on experience figures from other projects can limit the ability to adapt to new and unique factors in the new project. The cost estimation process should be flexible and allow assessment of project-specific characteristics and requirements. Uncritical use of experience figures can limit this flexibility and lead to incorrect estimates.

To avoid these hazards, it’s important to use experience figures from other projects as a reference point but also consider the unique characteristics of the new project. A thorough analysis of the project’s specifications, a comparison of relevant parameters, and an assessment of contextual factors can contribute to more reliable and realistic cost estimates. It’s also important to continuously monitor and update the budget based on the project’s progress and any changes in the assumptions.

In newspapers, TV, and other media, we often hear about projects that exceed their budget. Discuss to what extent this is due to poor cost estimation and budgeting.

Budget overruns in projects can be attributed to a variety of factors, and poor cost estimation and budgeting are definitely among them. Here are some reasons why poor cost estimation and budgeting can lead to budget overruns:

  • Lack of knowledge and experience: Poor cost estimation can occur when the project team or decision-makers lack sufficient knowledge or experience in the field. This can lead to underestimating the project’s complexity, underestimating cost drivers, or making incorrect assumptions about resource needs.
  • Insufficient information: Cost estimation relies on sufficient and accurate information. If there is not enough information available about the project’s scope, requirements, uncertainties, or other factors, it may be difficult to create realistic cost estimates. This can result in the budget not accounting for all relevant costs and thus being exceeded.
  • Lack of uncertainty assessment: A thorough assessment of project uncertainty is important for cost estimation. If uncertainties are not identified and assessed properly, unexpected events and costs may arise during the project. Failure to include uncertainties in cost estimation can therefore lead to budget overruns.
  • Optimistic assumptions: Sometimes the project team or decision-makers may be overly optimistic in their assumptions about project execution. This may include underestimating complexity, overestimating the team’s capacity, or making incorrect assumptions about collaboration with stakeholders or external suppliers. Such optimistic assumptions can lead to underestimating costs and thus budget overruns.
  • Changes in project scope or requirements: Projects may experience changes in scope or requirements along the way, which can impact costs. If budgeting does not account for such changes or if the changes are not adequately managed and controlled, the budget may be exceeded.

It’s important to note that cost estimation and budgeting are complex activities, and there is always a degree of uncertainty involved. Even with thorough and accurate estimates, unforeseen factors can arise that may impact the budget. Therefore, it’s also important to have effective project management and continuous cost monitoring to identify and handle budget deviations early.

Describe the major cost elements in the following project proposals:

  • Construction of an office building
  • Implementation of a new data system
  • Development of a new product

The major cost elements in the stated project proposals will vary depending on the project’s scope, complexity, and industry-specific factors. Nonetheless, we can identify some common cost elements for each of the project proposals:

Construction of an office building:

  • Groundwork and building construction: Costs associated with excavation, foundation, construction of the building frame, walls, roof, floors, and installation of building infrastructure.
  • Electrical and sanitary systems: Costs related to electrical installations, lighting, plumbing, HVAC systems, and sanitary facilities.
  • Climate control and ventilation: Costs associated with heating, ventilation, cooling, and climate control systems to ensure a comfortable and efficient working environment.
  • Furnishing and fixtures: Costs related to office furniture, workstations, meeting rooms, common areas, reception, kitchen, and other equipment necessary for the working environment.
  • Technological infrastructure: Costs related to network infrastructure, telecommunications, server rooms, data cabling, and other IT equipment to support office activities and communication.

Implementation of a new data system:

  • Software and licenses: Costs related to the procurement or development of software applications, databases, and necessary licenses to implement the new data system.
  • Hardware and infrastructure: Costs related to servers, network equipment, data storage, security and firewall systems, and other necessary hardware to support the data system.
  • Training and skills transfer: Costs related to training of employees or users in using the new data system, and any external consultancy support to ensure successful implementation.
  • Data conversion and migration: Costs related to converting, migrating, or transferring existing data from previous systems to the new data system.
  • Testing and quality assurance: Costs related to testing, debugging, and quality assurance of the new data system to ensure it works as expected.

Development of a new product:

  • R&D and design: Costs related to research and development of the new product, including design, prototyping, testing, and iterations to achieve the desired functionality and quality.
  • Materials and components: Costs related to the procurement of necessary materials, components, or raw materials used in the production of the new product.
  • Production equipment and facilities: Costs related to the procurement or upgrading of production equipment, machines, and facilities necessary for the production of the new product.
  • Labor and production costs: Costs related to hiring labor, production operations, production optimization, quality control, and logistics to deliver the new product to the market.
  • Marketing and launch: Costs related to market research, marketing strategies, advertising, promotional activities, and launching the new product in the market.

These cost elements are not exhaustive, and there may be other project-specific costs that need to be taken into account. It’s important to perform a thorough cost analysis and estimation based on the project’s unique requirements and scope to get a more accurate budget for each project.

Discuss the purpose of project reserves.

A project reserve is a financial buffer set aside as part of the project’s budget to handle unforeseen events, and uncertainties that may arise during the project. The purpose of the project reserve is to ensure that there are adequate funds available to handle unexpected costs, delays, or changes in the project without affecting the project’s overall objectives.

  • Uncertainty management: Project reserves are used to manage uncertainty related to costs, schedules, and other resources. By setting aside a reserve, one can prepare for unforeseen events and have funds available to handle them without affecting the project’s progress or quality.
  • Risk reduction: Projects always involve a certain degree of uncertainty. Project reserves help to reduce risk by providing a buffer for unforeseen costs or events that may occur. This gives the project manager and project owners greater security and the ability to handle risks in a more efficient manner.
  • Flexibility and change management: Projects can be affected by changes in requirements, scope, or external factors. By having project reserves available, there is greater flexibility to handle changes and adjust the project plan and budget accordingly, without having to resort to external funds or cancel the project.
  • Protection against unforeseen events: Unforeseen events, such as delays, technical problems, or changes in market conditions, can occur in any project. Project reserves provide a buffer to handle such events, so they do not have serious consequences for the project’s success or implementation.
  • Confidence and credibility: By including project reserves in the budget, project management and project owners show a responsible and realistic approach to project management. This helps to build trust and credibility with stakeholders, investors, and other involved parties. It also shows that project management takes uncertainty seriously and has a plan to handle it.

It’s important to note that project reserves should be managed and administered carefully. The use of the reserve should be based on careful assessment and decisions made by project management and project owners. The reserve should not be used as a general “slush fund”, but only to handle actual unforeseen events and costs that could not be predicted at the start of the project.

This case is taken from the book “Prosjektledelse – fra initiering til gevinstrealisering” – 2016, 4. Edition, by Jan Terje Karlsen.

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