Cost Estimation Classes and Methods
This report illustrates the cost estimation process followed for you, a junior estimator, to provide two cost estimates for Poly-Products Incorporated. Poly-Products Incorporated is a major producer of rubber components. On April 16, Poly-Products Incorporated received a request for proposal from Capital Corporation. Capital Corporation is seeking bids for 10,000 rubber components to be used as part of a complex project that must be manufactured according to specification supplied by the customer. The two cost estimates completed for this bid are a Class IV (initial cost estimate) and Class I (definitive estimate). The estimated timeline for the project according to Poly-Products Incorporated is 18 months.
Our approach to develop/calculate proper cost estimates was comprehensive; it included an introduction to the cost estimation process, an evaluation of the data sources for the cost estimates including a presentation of the Project Initiation Document (PID) and a Work Breakdown Structure (WBS), calculations to complete both Class IV and Class I cost estimations, and a recommendation of the cost estimation for this project.
A cost estimate is the approximation of the cost of a program, or a project. The American Association of Cost Estimation (AACE) defines cost estimation levels into five classes. Class V according to the AACE is the lowest level of accuracy and definition and Class I has the highest level of accuracy and definition. Each level has specific characteristics that are outlined in the following Figure (Figure X). The two cost estimates that are the focus of this report are Class IV and Class I.
Class VI, also known as a rough order of magnitude or concept screening, is usually completed during the initial stage of the project life cycle during the project selection and approval phase. This type of estimate is based on expert knowledge and experience. Since this type of estimate occurs during the beginning of the project life cycle limited information is known about the project therefore, this type estimate is not very detailed. Therefore, the accuracy of this estimate ranges from -20% to -50% and 30% to 100%.
There are three common methods for cost estimation: analogy, parametric and engineering build-up (bottom-up). Analogy cost estimating references cost of a similar program to estimate costs for new program. Parametric cost estimating looks for statistical relationships in one or more technical, performance, cost, or program parameters to predict costs for the new program. Bottom-up cost estimating requires cost estimates to be conducted at the lowest level of the Work Breakdown Structure and then rolled up to form the estimate for the new program. The strengths and weaknesses for each estimating method are identified in Figure X from NASA Cost Estimating Handbook Version 4.0.
Project Initiation Document
Before completing the cost estimation, it is important to understand the parameters of the company and project. These are defined in the Project Initiation Document (PID). The Project Initiation Document is created during the early stages of the project and provides the foundation for the project. The following subsections outline the Project Initiation Document for the Poly-product Incorporation case.
The purpose of this project is to illustrate the cost estimation process followed by a junior estimator to provide two cost estimates for Poly-products Incorporated.
- Manufacture 10,000 rubber components for Capital Corporation
- Meet delivery commitment to Capital Corporation on schedule
- Meet quality standards for the rubber components
Research, design, produce, and deliver 10,000 rubber components for Capital Corporation according to specifications supplied by the customer in accordance with Poly-products Incorporation quality standards.
The project constraints/exclusions are as follows:
- Poly-products Incorporated is a major producer of rubber components, but only employs 800 people. Their employee size could act as a constraint since competing companies of larger employee size could be more appealing to Capital Corporation.
The purpose of a work breakdown structure (WBS) is to break down the project into manageable components of work/deliverables known as work packages. A work breakdown structure is a hierarchical outline of tasks required to complete a project. The WBS is critical to being able to estimate the cost of a project especially at the Class I level.
A work breakdown structure was created for Poly-product Incorporation project based on the information provided in the case study. Each work package is defined in a clear deliverable format. This type of WBS is commonly known as a Deliverable Work Breakdown Structure (DWBS). For this type of WBS it's important to define the work packages using nouns as opposed to verbs in order to highlight what the work package is delivering.
Cost estimation analysis is imperative to a project’s life-cycle. When conducting estimations at higher class levels, there are less details and less accuracy in results. When conducting estimations at lower class levels, more details are readily available and the results have a higher level of accuracy. The two cost estimates completed for this bid were an initial cost estimate (Class IV) and a definitive estimative (Class I).
Two cost estimations were completed for Poly-Product Incorporated bid to Capital Corporation in order to complete the project of producing 10,000 rubber components. These two cost estimates were based on the critical information and data provided by the Project Initiation Document and Work Breakdown Structure as well as information provided by subject matter expertise in the case study document. The Class IV estimate was a preliminary estimate where the main focus was on obtaining a logical estimation of direct and indirect costs to calculate the total project cost. The Class I was a much more detailed estimation of the direct and indirect costs. Additionally, under the Class I estimate, a risk analysis was conducted in order to determine an accurate contingency reserve.
The Class IV estimate for Poly-Product Incorporated bid to Capital Corporation was estimated to be approximately $10 million. The level of project definition for this Class IV estimate is between 1% and 15%. The accuracy of this estimate is between -15% to -30% and +20% to 50%.
The Class I estimate for Poly-Product Incorporated bid to bid to Capital Corporation was estimated to be approximately $12 million. The level of project definition for this Class I estimate is between 65% and 100%. The accuracy of this estimate is between -3% to 10% and +3% to +15%. Based on these characteristics of the class estimates according to the AACE, it is recommended that Poly-Product Incorporated bid to Capital Corporation be valued at the Class I estimate at $12 million.
Uncertainty is a crucial component of any cost estimation to consider because 100% accuracy is improbable. Yet, applying rigorous tactics when completing cost estimation is critical and beneficial for the long term success of any project. By utilizing both cost estimates, the process from Class I level presents more detailed and thorough information. This thorough analysis therefore provides a higher accuracy in estimation for Poly-Product Incorporated. Cost estimation is a crucial element of any project because cost estimation projects the price of a project, but also promotes stronger management of budget, time, scope, quality and risk.