2005 AACE International Transactions

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Effective Cost Management—Back to Basics

Mr. Robert L. Tichacek, PE

his paper addresses cost management and its primary fessionals we are obligated to manage all areas and indices of a

T significance as a measure of project success. All proj-

ects are managed and measured by success criteria of
several types, cost being only one of many important
metrics—but cost as a resource and as a measure possesses unique
attributes which differentiate it from other project measures and
project's success. Yet the topic and content of this paper focuses
only upon cost. Why? This does not reflect a feeling on the
author's part that cost is in itself intrinsically more important or
valuable than say quality or time. It is because the author has
observed and experienced that cost as a measure and as an indi-
requires unique considerations and methodologies in order to pro- cator is universally used, easily understood, requiring no special-
vide for its effective management. This paper considers: ized knowledge of any kind, and enables a simple common
denominator with which to normalize all comparisons. There are
• Cost as the standard measure of project success—having also unique attributes about cost as both a measure and a standard
higher visibility and requiring extremely effective methodolo- that are not shared by other measures. These unique qualities in
gies for managing and communication; turn present special challenges in management methodologies.
• Cost management vs. cost accounting—requiring different
methodologies and a higher level of involvement by the proj-
ect team; COST IS...
• Cost management as a process, not a discipline, requiring the
integration of effort and inputs from multiple persons using
prescribed methodologies; The Most Common Measure of Success
• Total cost as the most important concept to the organization; All projects are measured against some performance criteria
• Organizational goals for cost management are often in con- that indicate whether the project is successful or not. There are
flict with project goals, yet must be aligned and addressed. many criteria, all important, that we regularly incorporate when
establishing performance metrics. Time, quality, safety and cost
This paper offers methodologies for: are some of those. Cost however is the measure that is most often
presented and is widely understood as an indicator of how well a
• An effective and thorough three-point cost management project is performing, is likely to have performed or has per-
approach; formed.
• Managing total cost; Even projects driven by other metrics will rationalize strate-
• Satisfying organizational needs in addition to project needs. gic decisions on the normal basis of cost. For instance, a project
that is schedule driven is usually only this way because the pay-
back or deliverable promised by the project exceeds the savings
COST MANAGEMENT, AN OVERVIEW that might be experienced by extending the execution time. Cost
is an easily understood common denominator used to rationalize
Projects are described and defined by metrics and measures. a decision to, say, incur the additional costs of accelerating an
Quantitative comparisons signify distinctions between success existing schedule or to accept greater costs in developing a time-
and failure, good vs. very good or suggest 'go' vs. 'no go' to us. We optimized baseline execution plan 1.
not only measure outcomes, but we then compare them against Finally, there are many project participants—either direct
norms established as thresholds of acceptability. stakeholders or beneficiaries as well as others having oversight
Projects are measured using many factors and compared roles at corporate, non-project levels who better relate to and more
against just as many standards. Safety time and schedule, quality easily understand cost as a measure and yardstick for perform-
and User Satisfaction are important to projects and are thus meas- ance. Theirs is the world of return on investment, the bottom line,
ured and compared against either universal/external standards or or time to payback indices; the concepts of rarned value, SPI, or
project specific/internal standards. As project management pro- CPI are lost on them.

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This paper does not suggest that cost is the more important • Projects are insistent about and capable of seeing that there is
metric, only that it is the easiest to comprehend and therefore the expenditure quid pro quo—that monies are appropriately
most common and that the ability to frame any/all project per- spent and receive appropriate value in return.
formance measures within the context of cost should be well with- • Projects have mechanisms to prevent overspending—not only
in the capabilities of any project management or project controls relative to their budget, but also relative to their need. That is
professional. to say, funding that might possibly become excess through
But beware! This can be a species argument and a misleading value management, reductions in scope, unrealized risk, etc.
justification for spending foolishly. All too often spending deci- will be identified and will returned to the organization at
sions are suggested and approved on the basis of buying time appropriate times.
when in fact an expedited delivery or accelerated task is not on the
critical path and has no discernible benefit to the project.
Remember that one of the four goals of cost management is to COST MANAGEMENT VS. COST ACCOUNTING
spend wisely, i.e. to ensure that a unit or more of value is received
for every unit of investment. All organizations identify cost management as a goal and a
practice. Managing cost however differs greatly from accounting
for them, and while many organizations feel that they are manag-
The Most Finite Resource ing costs, they are in fact they are only accounting for them. Such
Projects are expected to complete within the confines and organizations are depriving themselves of the benefits that man-
limitations of the resources allocated to them. A project that has agement processes deliver.
been approved on the basis of a budget estimate is expected to Simply stated, cost accounting addresses “how much” and
complete having spent no more than that amount. “what for.” It is not analytical and merely address history or tells us
If a project's time management has failed, i.e. too much work what happened. Cost management focuses upon measuring per-
remains at the completion of the schedule, then more time is formance, comparing against expectations and finding reasons for
needed to complete the project. While the need for more time divergence. Cost management also endeavors to predict final out-
may not be acceptable, time is, as a commodity, available. Time comes and to provide strategic recommendations for changing or
itself is infinite. There are always more hours, days, weeks and mitigating such. Cost management is forward looking and
months that will occur post-deadline and does not require bor- attempts to answer why, what it means and what can be done
rowing, issuance of bonds or trading off between other initiatives. about it.
While time allotted runs out, time itself continues on and is avail- Cost management is not good to cost accounting's being bad
able. The need for it may well reduce salaries, eliminate bonuses —they are both different, perform different functions and are both
or even ruin careers, but it is available. necessary. In fact, cost management cannot be performed without
Money is not infinite—or certainly not within the context of having an adequate cost accounting process in place.
the project or corporate organization. When allotted monies are The irony is that a larger, disproportionate share of the costs
gone, you must obtain more if you wish to continue the project. incurred in employing a cost management methodology is in the
You must litterally beg, borrow or steal from other project funding budgeting, allocation, recording and reporting of costs—the
opportunities or the project will be forced to a halt. accounting side. Whereas employing the processes to effect a
complete management capability requires little added cost.

The Most Competed for Resource

Corporations are forced to make choices when appropriating COST MANAGEMENT OBJECTIVES
funds for approved projects. To obtain approval, every project ini-
tiative that is presented must make a business case or demonstrate There are four objectives in cost management:
a tangible benefit to the organization based upon the project's
deliverable. In the typical corporate scenario, there are many proj- • Spending timely—Ensure that money or resources are
ects worthy of investment and approval, but with a finite avail- expended in accordance with the project or corporate capital
ability of money, only selected ones can be funded within a given expenditure plan;
planning and budgetary cycle. • Spending wisely—Ensure that monies are well-spent, i.e. that
Competition for project funding within an organization is a planned unit of gain is achieved for each unit of expendi-
vigorous. In making these choices, management must rely upon ture;
the accuracy and relevance of the information and data underly- • Spending correctly—Ensure expenditures only for those
ing the cost versus benefit statement. They also need to feel things for which we are obligated;
assured that: • Spending perceptively—Ensure that spending versus
achievement variances are identified, analyzed, corrected or
• Projects are not over-funded, denying funding for other proj- trended so that early warnings can enable timely actions.
ects thus depriving a benefit to the organization.
• Projects are not under-funded, and inviting a cost-to-com-
plete crisis at a later, more critical time.

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Figure 1—Spending Timely and Spending Well—Both Required.

EFFECTIVE COST MANAGEMENT IS… management initiatives include facility operations and mainte-
nance personnel as participants or only project personnel? Does
the project manager regard cost management as the team's
A Process Rather Than a Discipline responsibility and ensure the integration of cost management
The function of cost management is often regarded as a dis- thinking and action into the ongoing project operations, or do
cipline or as a position within a project structure and assigned to they abrogate that responsibility to the cost engineer and limit
individuals rather than to teams. their involvement to being attendees only during monthly or quar-
Cost management requires processes and methodologies that terly cost review sessions?
can only function with information development and knowledge
hand-off and enhancements. This is made possible through the
deployment of assignment, collection, assessment, analysis,and Performed by people, not products
strategic decision making processes. Cost management is a man- There is no software or tool that manages cost. Tools can simplify
agement function and responsibility and must be performed by or facilitate the tasks of recording and reporting cost, but the
teams using recordable and repeatable methodologies. process of managing cost is dependent upon properly estimating,
allocating, measuring and analyzing cost performance.
The integration of processes and knowledge from multiple Management requires that information be analyzed and acted
functional roles—Effective cost management requires involve- upon. Analysis of alternatives, “what-if” comparisons and recom-
ment and interaction between many individuals at different levels mendations based upon strategic thinking can only be performed
having different roles and skills. It demands that all persons by project controls professionals!
employing management methodologies interact in a synergistic
fashion. Cost management practice areas are too often compart-
mentalized and singularly tasked, allowing only minimal infor- TOTAL MANAGEMENT—
mation exchange or knowledge enhancement between silos. In THINKING BEYOND THE PROJECT
your organization, is estimating performed as a stand-alone func-
tion, or is there participation with and knowledge integration with Organizations initiate and provide funding for projects, and
those developing the execution plan and strategies? Do value organizations receive the benefits from completed projects.

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Figure 2—Think Llife-Cycle, Think Total Cost and Think Benefits.

Project teams are formed to execute these initiatives, but others execution metrics, cost, etc, it is easy for our involvement within
within an organization have responsibilities for and are affected by a project to obscure our view of a bigger corporate picture.
the operations and outcomes of the project team. While the both Irrespective of that, it is important to remember that the corpora-
organization and the project desire success, their goals and suc- tion has needs that must be served as well as the project.
cess measures can be different and often in conflict. Our roles as project management professionals often lead us
The Project team would consider opportunity for an early into conflict regarding the calculation and analysis of costs versus
completion good whereas the financial group might be concerned benefits. Organizational expectations, project team versus corpo-
that an early completion, even without added costs, would cause rate staff, or functional role constraints, owner's representative ver-
a deficit in cash available to pay the contractor as the capital sus CM at risk, will have influence upon and will affect our view-
spending plan is violated. Remember that most capital plans are point and decisions regarding appropriate actions in managing
funded and financed by borrowings that occur within timeframes project costs. The CM at risk or CM having shared participation
set by the program or capital plan. To the comptroller, even under cost savings/cost overruns has every incentive to promote the
spending is bad as it signals to them that funds were not really deferral of costs to cost centers beyond the capital center—rec-
needed and could have been available for other corporate initia- ommending, for example, lower-priced mechanical equipment
tives. Likewise, a decision to delay a project, for reasons that were that might result in lower 1st costs but increase maintenance or
prudent by project standards, might conflict with a larger need or energy costs. Likewise, facilities personnel charged with success-
benefit to the operations group. fully operating and maintaining the completed project will have a
The project team manages project performance, while the similar bias toward obtaining the easiest and least costly operating
organization manages expenditure and project benefit. These conditions, without consideration for inordinately high 1st costs
needs must be aligned and integrated, and managed considering bearing little additional value.
the bigger picture. This requires involvement of the executive Our responsibilities as project management professionals
sponsor who is empowered and charged to make decisions based require that we think beyond just the capital or any single expense
upon organizational benefits. component. We need to consider the optimal balance between
first costs and life-cycle costs and to provide dispassionate, objec-
tive analysis to owners or investors with recommendations based
TOTAL COST—THINKING BEYOND THE PROJECT upon the best possible solutions. We are familiar with the “pay me
now or pay me later” concept—we must realize the for the “pay
me more/less now or pay me less/more later” concept as well.
Project Success: Successful Execution vs. Successful Project
We must distinguish between a successfully executed project
and a project that is successful! Projects are not approved and THREE POINT COST MANAGEMENT APPROACH
funded on the basis of their estimated costs and/or execution
plans—they are approved only because the value of their bene-
fit(s) is greater than the sum of the costs. Likewise, project spon- The Cost at Completion Triangle
sors are measured by and rewarded based upon the successful This graphic represents a fixed volume of cost, measured in
delivery of the promised benefits for which the project was initiat- money, resources or even time, that the project represents as suf-
ed. Because the project team is gauged mostly by compliance with ficient for execution and to provide all project deliverables. As

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• Thorough understanding of scope and project deliverables—
are there clearly communicated criteria and expectations?
Other agendas?
• Benchmarking—How does project compare with similar
industry projects? With similar company projects?
• Integration with project execution plan—does the estimate
incorporate time requirements and special execution strate-
gies that might be decided upon external to the estimating
team, or is the estimate just a summation of take-off quanti-
ties extended by pricing unit rates?
• Accuracy of take-offs and extensions—Has an audit been per-
formed?

Perform risk analysis and develop mitigation strategies—

Success metrics are assumption-based—no matter how carefully
or thoughtfully developed. Measures of cost or time performance
Figure 3—Manage the Points, Contain the Cost. and success are based on criteria that have been created for the
project. These criteria assume that certain things are correct, that
with any geometric shape, the volume can only remain constant certain things will happen and/or that certain things will not hap-
if the boundaries remain fixed. pen. For instance, we assume that certain benchmarks or histori-
The suggested approach is to consider and develop strategies cal productivity rates are repeatable, or even correct, or that key
with which to manage each of the points of the triangle, and then vendors will comply with our delivery requirements, or even
implement process that support those strategies. remain in business, or that labor unrest will not occur.
Risk is in the possibility that reality will trump reasonable
expectations and leave us unprepared for the impacts not budget-
Point 1: Ensure the Accuracy and Completeness of the Baseline ed. A risk management process will:
Estimate
Nothing is worse than managing to the wrong number! • Identify risks and threats,
Projects are threatened or have failed because of the inability to • Assess the probability of occurrence,
meet expectations imposed by estimates that are incomplete, con- • Gauge the severity of impact should they occur,
tain invalid assumptions, are erroneous or contain no provision • Estimate the cost of mitigation, avoidance, transfer or elimi-
for surprises or unknowns. Mistakes can and do happen of course, nation.
but unfortunately they are often discovered well past the point of
no return. At that point, there may be few with options for recov- Ensure inclusion of appropriate contingencies, reserves and
ery short of assaults upon scope integrity and functionality—per- allowances—The costs of mitigation, avoidance, transfer or elim-
haps disguised as value management, or establishment of a con- ination can be incorporated into the estimate. Risks whose impact
tentious environment in which of all information, directives or cannot be quantified can be included as part of a rational basis for
requests are interpreted as change, resulting in the seemingly end-contingency development. Contingency is established to mitigate
less war of claims. or eliminate the adverse impacts of the unforeseen or under-pre-
The best way to solve a problem is to prevent it—simple dicted events.
processes can and should be deployed during the development Allowances are not risk-based. They provide funding for proj-
phases of the estimate and continue through the delivery of the ect elements and events that are anticipated and within the scope
completed definitive or baseline estimate. Some strategic process- of the project, but cannot be quantified as the project or design
es include: development is in its early stages and will continue to evolve.
Management reserve funds are common to project manage-
• Review and validate the basis of estimate (BOE); ment. These funds are usually typified as discretionary funds that
• Perform risk analysis, develop mitigation strategies and create may be applied by the appropriate level of management for any
appropriate contingencies, reserves and allowances; purposes that they choose.
• Perform value management reviews—initial and at appropri-
ate project stages. Setting contingencies—considerations—Care must be exercised
when setting contingencies for risks.
Review and validate the basis of estimate (BOE)—There are It is important that contingencies be sufficient to cover the extent
many possible errors in preparing an estimate that can understate and probable impacts of risk. It is equally important that contin-
or overstate the capital or resource requirements for the project. gency does not exceed needs. Over budgeting of contingency has
Some actions and steps to either ensure greater accuracy or to two undesirable effects:
detect errors include:
• The company is deprived of funds that might be better used
• Scope review—all present and accounted for? in other ways or for other projects;
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• Unspent contingency monies will find their way to funding • Increased benefits from project components or processes;
scope changes, enhancements, and other elements that • Removal of unnecessary features, functions and costs;
should properly be purchased with allowance or reserve • Without compromise of project scope and benefits;
resources. • With full ttakeholder backing and ownership of solutions.

Risk changes with time and completion progress. The available

contingency should reflect these changes by readjustments Point 2: Manage Production and Productivity
through periodic reassessment and quantification of risk. Project execution costs will be affected by variances or gaps in
production goals as well as by productivity assumptions in the per-
formance of the project tasks.
Initiate and Incorporate the Value Management Process Shortfalls in accomplishing the planned units of work per
unit of time will either delay the project incurring additional costs
Optimizing the value received relative to the investment associated with such extension of time or necessitate the addition
made—The primary goal of the value management (VM) process of resources with the added costs associated with acceleration.
is in optimizing value, not cutting costs! Optimizing value implies Productivity variances will require greater-than-budgeted
the achievement of greater benefit per unit of cost, not just a lower units of input per unit of output and will either require additional
total estimate cost. While costs can be reduced through the VM time to complete, i.e. prolong the schedule or will necessitate
process, it is really as a result of identifying and removing features additional resources with the added costs associated with such.
or functions whose cost is greater than the benefit they provide or The crux of managing production and productivity is in hav-
as a result of substituting features or functions having equivalent ing the capability to identify variances early enough so as to allow
value but lower cost. Conversely, a VM implementation might corrective action. Note the operative words are identify and early
result in an increase in the project estimate if added features con- and apply to both production and productivity!
vey a benefit greater than their cost. Although most projects have established methodologies for
One risk that must be managed during the VM process is the planning, measuring and analyzing production—few projects
temptation to eliminate or reduce scope for the simple sake of have any established process for measuring and analyzing pro-
reducing costs. This can result in cost reductions but may not be ductivity. Both processes are necessary for effective project, and
cost savings, particularly if compromising the scope reduces cost, management and control.
desired features or functions of the project—or if life-cycle costs,
or total cost, increase irrespective of a one-time, front-end reduc- The earned value solution—Earned Value analysis is one
tion. methodology that enables the simultaneous analysis of production
Another risk is the assumption by many that greater quality and productivity. It also provides an immediate assessment of pre-
means increased value. This is not true—quality greater than dicted outcomes at completion, early warning, while displaying in
quality required does not equal greater value, only greater cost. one view a three-way comparison between what was planned,
The first step in implementing a VM process is the develop- what was achieved and how efficiently. The definition of earned
ment of a project value hierarchy. This will clearly prioritize ben- is simple: when a task or portion of a task is accomplished, the
efits, establish rules of engagement and define the tie-breaker to resources , cost or time, are earned. Earned equals budget times
be relied upon when considering trade-off, trade-up and trade- percent complete, and earned' is independent of expenditure.
down options. Earned value is the analytical technique that measures results rel-
ative to effort and allows us to manage cost and time on the basis
of performance. The ability to view schedule/budget/cost simulta-
Successful implementation of the VM process requires: neously and to immediately detect variances provides us with the
capability to trend or predict outcomes at completion and to
• A project value hierarchy; receive early warnings that enable actions in time to make a dif-
• Early engagement of the process—when the cost of change is ference. I do not feel that projects can be successfully executed
lowest, therefore optimizing the cost to benefit ratio; without the use of the earned value methodology. The irony is
• Participation by the all project stakeholders—so that benefit, that it is resisted by many because it is thought to be overly ana-
value and total cost considerations can be fully vetted; lytical, complex, difficult to use and requiring significant invest-
• Consideration of total cost; ments in resources. In fact it requires no additional information
• Distinction between cost transfers or deferrals and cost sav- than is already generated on most projects and requires very little
ings; additional effort.
• Real estimates of costs and benefit;
• Review of processes as well as product; Steps for the successful implementation of earned value:
• Focus on value—not cost;
• Support and acceptance of conclusions by team. • Develop performance standards, basis of estimate;
• Develop work breakdown structure (WBS);
With following outcomes to be expected: • Allocate cost/time budgets to appropriate WBS level;
• Collect actual expenditures—cost, time, other;
• Optimized value relative to investment; • Measure accomplishment, percent or units;
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• Measure/compare performance—Actual versus planned ver- • Proposed change review process—review against scope, cate-
sus earned; gory cause/reason, benefit/cost analysis from total cost per-
• Keep it simple and make it easy to use! Measure percent com- spective;
plete or work accomplished at the task level, but estimate, • Gatekeeper process—yes/no, appropriate approval;
allocate and collect costs at a higher WBS level! • Scope control equals expectation management;
• Identified funding source;
• Funding/impact adjustments;
Point 3: Manage Scope and Control Change • Learn to say no—whenever appropriate.
Change, scope creep, modifications, revisions—dreaded
words and certain budget breakers on any project! Unfortunately,
we can't run from it, we can't ignore it, and we most certainly ost is the universal and most highly visible perform-
can't prevent—but we can manage it!
The first step in managing change is to understand why it
happens. The notion of change being intrinsically bad is an incor- C ance metric for indicating project success. Cost is
also the most competed for corporate resource. Cost
is considered as a finite resource. As such, we as proj-
rect one. Events that are external to the project such as evolving ect management and project controls professionals must be will-
technology, changing business models, swings in world market ing to expend the effort and intelligence necessary to properly
conditions, may necessitate the seizing of opportunities with manage it.
which to reconfigure, readapt or enhance the project. Remember Often mistaken for or confused with cost management, cost
the concepts of total cost and benefit and that it's not just about accounting differs greatly. Cost accounting provides a record and
the project's capital budget. history of expenditures but does not by itself manage and control
Our challenge is to manage change by identifying and classi- final cost at completion outcomes. While providing a necessary
fying proposed change by driver or root cause and to demonstrate and beneficial function, it is best used as a platform for effecting a
the added cost and/or benefit in adopting the change. There are cost management process.
some change issues that are simply beyond the purview of project Cost management should be regarded as a process requiring
team to accept or reject. In these instances our obligation is to the integration of separate discipline methodologies and the
ensure what we do the following: involvement of many persons who are both part of and external to
the project team.
• Validate change—verifying that it is not already within scope Meaningful cost management requires thinking and acting
or range of project expectations; outside the project. This implies that cost and benefits be consid-
• Ensure the change is needed or is beneficial; ered in total and not limited to a project's capital budget, that
• Is obtained or implemented at the right price, in the right organizational requirements be considered, and that the some-
time, in the easiest way; times competing goals between projects and corporate entities be
• Is documented and we can demonstrate its driver, its benefit, optimized and aligned.
and its cost; Effective cost management requires the implementation of
• Has been reviewed and approved by appropriate levels; methodologies and steps that are repeatable from project to proj-
• Has an identified and approved funding source from contin- ect and can be integrated with organization goals.
gency, management reserve, budget transfers or offsets, etc.

Proposed or requested changes can be categorized into three Mr. Robert L. Tichacek
types: “got to haves,” “Should haves,” or “Want to haves.” Category Saybrook Associates, Inc.
three can become category two through value analysis—or even 12 Industrial Park Road
category 1 via organizational politics, but in many instances these PO Box 21
are requests for extra and additional features that might benefit Centerbrook, CT 06409
one or even several users but do not contribute value to the proj-
ect or its deliverables. Change management now evolves into E-mail: rtichacek@saybrook-associates.com
expectation management. As project management professionals
we are wired to say yes, we are after all the can-do-profession. We
must, however, be successful in three areas of expectations.
Establishing expectations and delivering expectations are process
based and can be performed with developed methodologies.
Managing expectations is much more difficult, often requiring us
to act contrary to our nature, and is a personal skill not easily
learned!

Steps for successful change management:

• Set and communicate expectations—detailed scope docu-

ment distributed to all stakeholders;
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