Are you Quoting your Estimates with the Right Amount of Uncertainty?
Challenge
You have heard me reference the Project Management Institute’s (PMI) A Guide to The Project Management Body of Knowledge (PMBOK), Third Addition on previous blogs. This blog is no different. I would like to make sure for all future blogs on the subject of Cost Management that we are starting from a common foundation.
According to the Project Cost Management includes “the processes involved in planning, estimating, budgeting, and controlling costs so that the project can be completed within the approved budget” (p. 153). One of the challenges Program and Project Leaders have is setting proper expectations with respect to estimate accuracy. So, I would like to clarify the difference between the three (3) basic types of estimates: Order of Magnitude, Budgetary and Definitive.
Helpful Hints
- Order of Magnitude Estimate – An Order of Magnitude estimate is prepared during the Initiating stage and has an accuracy expectation of -25% and +75%. So, if you are quoting an Order of Magnitude estimate for a work effort you believe will be around $5.0 Million dollars. A representative quote might be “We believe the cost of the project will be between $3,750,000 and $8,750,000”. The lower range is calculated by taking 25% of the $5,000,000 number and subtracting. The upper range is calculated by taking 75% of the $5,000,000 number and adding. You could quote $5,000,000 minus 25% or plus 75% but, my experience with most Senior Leadership Teams is they DO NOT want to do the calculation (they would rather check your calculations – smile). It is highly recommended NOT to quote a single number otherwise, people get fixed on the single number instead of the range.
- Budgetary Estimate – A Budgetary estimate is prepared during the Planning stage and has an accuracy expectation of -10% and +25%. So, if you are quoting a Budgetary estimate for a work effort that you believe will be around $5.0 Million dollars. A representative quote might be “We believe the cost of the project will be between $4,500,000 and $6,250,000”. This lower range is calculated by taking 10% of the $5,000,000 number and subtracting. The upper range is calculated by taking 25% of the $5,000,000 number and adding. Again, it is highly recommended NOT to quote a single number.
- Definitive Estimate – A Definitive estimate is also prepared during the Planning stage and has an accuracy expectation of -5% and +10%. So, if you are quoting a Definitive estimate for a work effort that you believe will be around $5.0 Million dollars. A representative quote might be “We believe the cost of the project will be between $4,750,000 and $5,500,000”. This lower range is calculated by taking 5% of the $5,000,000 number and subtracting. The upper range is calculated by taking 10% of the $5,000,000 number and adding. Again, it is highly recommended NOT to quote a single number. I hope this helps. By the way (BTW), for those of you preparing for the Project Management Professional (PMP) exam, you may find this background information useful.