Cost Estimation

Contents 1 Applications 2 Procedures 3 Instructions 4 Example 5 References

A technique to estimate all costs associated with performing an enterprise change project or product development activity. Cost estimation can be performed using a bottom-up or top-down approach. When using a bottom-up approach, the costs are calculated on a unit level, then rolled up to the top level. The cycle time, number of people, and cost per person are used. The top-down approach is general and does not break out costs in detail, but could identify major cost drivers (e.g., hardware, software). However, it is important to use a consistent level of detail when estimating benefits to enable a common cost benefit analysis. (See Benefit Estimation and Cost Benefit Analysis.)

Applications

• To estimate the direct and indirect costs associated with implementing the redesign recommendations and new redesigned activities.
• To estimate the current and future costs of an activity work flow or value stream.
• To estimate the cost, schedule and quality of a product development project.

Procedures

1. Determine direct costs.
2. Determine indirect costs or the costs that produce intangibles.
3. Calculate the savings between current and future expenditures.

Instructions

To determine the estimated costs of a reengineered activity, start with the activity flows which may be drawn from the Activity Based Costing (ABC) results or the Activity Profiling information. Estimate the activity costs associated with the new process by adding together the costs of the new/modified activities. If neither ABC nor Activity Profiling techniques were used in a preceding task (see Activity Based Costing, Activity Profiling), create a cost breakdown structure of the process, linking all costs to their associated activities. The work flow diagram (see Work Flow Diagramming) is an effective medium for presenting the breakdown structure. Capture all lifecycle costs for each activity, and record them on the work flow diagram.

Identify staff involvement associated with those activities or processes. People assigned to the reengineered process should have known costs. For those people who have not been accurately identified in the process, define the new roles and responsibilities of the people likely to be chosen to implement the new activity or process. Estimate the cost of the roles associated with each process.

The costs are measured by estimating the level of effort (in units of time) required by each individual attributing to the activity; calculating the individuals fully burdened (i.e. overhead costs included) labor cost per unit of time; then multiplying these figures. The cost of materials consumed in each activity should also be recorded.

Further, the overall costs of the reengineering implementation in process redesign will include both recurring and nonrecurring costs.

Examples include:

• Recurring:
• operational salaries
• facilities
• materials
• overhead associated with above

• Nonrecurring:
• development/engineering salaries
• development tools
• capital equipment
• training
• trade studies
• cut-over, setup, or conversion

Life-cycle costs should be recorded in tabular format (see the following example) to facilitate a merge with benefits in a Cost Benefit Analysis (see Cost Benefit Analysis). Note, the project lifecycle (five years in the example figure) should be determined in accordance with corporate standards. Also, corporate standards may require a discounted cash flow be applied to the life-cycle costs, in which case present value or not present value costs (adjusting annual costs by the discount rate of return) must be included in the cost estimate.

In lieu of the bottom-up (activity cost breakdown) method of estimation described above, redesign and implementation costs may be estimated by using a top down approach. One method is to use cost estimates from completed project activities similar in scope to the new redesigned activities. Other methods include simulating the new process (see Simulation), using cost as the key performance measurement. Benchmarking is another method where costs incurred for similar processes in other organizations is required.

In all cases, scaling the estimate to the historical "similar-to" costs is critical. Historical size data (as well as cost, time and quality) can be very helpful during this process. This is particularly true for software development projects, where non-recurring effort is highly dependent on how much software needs to be developed.

Example

References

1. V. Daniel Hunt. Quality in America, How to Implement a Competitive Quality Program. Business One Irwin, 1992.
2. Dr. H. J. Harrington. Business Process Improvement, The Breakthrough Strategy for Total Quality, Productivity, and Competitiveness. McGraw-Hill, 1991.