Project Cost Estimation : Promoting quality of cost estimation to reduce project cost variance

Abstract

One of the dimensions of evaluating project success is assessing whether the project has been completed within the assigned budget. However, it is unlikely that the actual costs will be exactly as planned, and historically, industrial projects are prone to cost overruns. Careful planning and a reasonable cost baseline are key to achieving project success. The cost baseline consists of the aggregated cost estimate and contingency reserve. Literature identifies various methods for increasing the reliability of the cost baseline via setting appropriate contingencies. However, there is a gap in the literature regarding the other of the two components of the project cost baseline – the cost estimate. The objective of this thesis is to investigate and develop a method for reducing project cost variance by improving the quality of the cost estimation process in industrial project-based firms. The objective was achieved by observing the sales organization and the cost estimation procedure in the case company and identifying the underlying issue that results in the project cost variance. The method was developed by surveying the best available practices of cost estimation techniques and processes employed by industrial project organizations and synthesizing a holistic method for improving the quality of cost estimation and promoting knowledge management within an organization. From a practical perspective, the research offered the case company a new point of view on cost variances in terms of element-specific variances. This analysis revealed the need to update the cost estimation tools for specific elements in the company’s product portfolio. From a managerial perspective, the work emphasizes the information and procedural requirements of the cost estimation process. Furthermore, the work provides advice on employing alternative cost estimation techniques to balance resource utilization as well as making the process more lean. A new risk category that roots from within the organization was identified and the findings of the thesis suggest that this category should not be a part of the contingency reserve. The internal foreseen risks can be managed with procedural changes. The thesis proposes a stage-gate standardized model for cost estimation, that guides the organization to select an appropriate cost estimation technique corresponding to the stage of project preparation. The findings suggest that the cost estimation process should be followed systematically, and to proceed with the process, all milestone requirements should be met. In addition, the role of the historical information database was deemed central to the quality of the cost estimate, making it imperative to accentuate diligent high-quality reporting and knowledge management practices.