CLASS #01- Types of Cost Estimation

1. CLASS 01 - INTRODUCTION: Hi, I am Said Soliman. I'm a Projects Management consultant and acting as Managing Director for consultancy firm called "EDGE" for cost management. In My role, I worked with a lot of teams, whether they are from agencies, startup companies, internal teams, or corporations, and help them solve their project management challenges, especially in the scope of cost analysis or in the rule of business process management and the ERP implementation. In our class. I will clarify the different and the common methods of cost analysis and what's the difference between them in terms of use, method of analysis and the amount of information required for each method. This is to determine the method that suites your needs according to the nature of the project and the purpose of the study. In this class, you will learn about is the main and the most common types of cost estimation like Rough Order of Magnitude method, Preliminary Estimation Method, Substantive Estimation Method, and Definitive Estimation Method. What's the related techniques of estimation for each method? Like Analogous Technique, Parametric Technique, and Three-Point Technique. and that to enhance your choice for the best methods that matching your requirement to estimate the project cost. By the end. and to make the best out of this class, I recommend you to use one or more of the technique from this class to put together an outline of an approach for a project you are planning to estimate. And that by answering the following question to consider when building your outline. What's this type of question? First, what's the purpose of estimation for this project? How much information is available? What's the level of accuracy required? Thank you. And let's get started. Our first lesson. 2. WHAT ARE THE TYPES OF ESTIMATION ?: Welcome to the first class from the subject of principle of project cost estimation. In this class, we will talk about common types of project cost estimates and what's their criteria which enhance our choice for the best method is that matching our requirement to estimate the project cost. First, we must clarify what is meaning of cost estimate. Cost estimate, a quantified expectation of how many resources are required to complete a project. Such cost estimates are often expressed in currency units. However, other units such as man-days, can also be used if the current amounts are not applicable. or irrelevant. Now the question is, how many methods we can use to implement estimation process? Actually, there are different types of cost estimates. And this class, we will talk in detail about the main and most common three types of cost estimation and what is related techniques of estimation for each method. The first one is the approximate estimate by volume, which is called also rough order of magnitude. This type of estimate is used to for project screening or deciding which among several projects to proceed with. That often based on high level expert judgement, sometimes in conjunction with the three-point estimating, which is one of the estimation technique that reflect the average of optimistic, pessimistic and most likely estimate. Second method is the initial assessment of the main project item, which is called the preliminary estimate and also called the budget level estimate. And this type of estimate is used to support in decision to choose among the various options available or to make a decision to proceed with one alternative over the others. Accordingly, estimate needs only to be as detailed as necessary just to compare between alternatives. The last method is the accurate method of analyzing and determining the price of each item of the project. and this method called substantive estimate. This estimate breaks down a project into its component parts and uses all available information to assign a cost to each part. The pieces are rolled up into an overall estimate, then contingencies and margin and the profit are added just to in their summation to estimate the sale price. Now to facilitate understand of the different cases in which the previous methods of projects pricing are used. I will illustrate these cases with an example. Suppose that a construction company nearing capacity of employees, at its headquarter building. And I identify the need for an expansion. And the construction work for such expansion definitely will be executed by them as they are already a construction company. Two years prior to construction. An order of magnitude estimate is developed to understand the scale of the expenditures that implemented based on price of previous similar project or based on expert judgment by considering the common price in market for the square meter of building area, built-up area for such type of building, which is a CEO, uses to make the decision to proceed with the construction of new building for expansion and saves the required budget that will be considered in the further financial plan for the company. One year later, and as they became closed for the execution of such expansion project team present the CEO with several options for expansion. Even it was vertically, so additional floors or horizontally through the construction of adjacent new building. Based on these alternatives, the initial design and configuration assigned for each alternative, and accordingly the preliminary estimate for the major trades ONLY implemented. Why the major trades? Because the initial design just give us information about the major, information about the building. Based on these estimates. One of the expansion Design is chosen, six months later. The chosen expansion has been completely designed. Quantity of material are known. In this stage, a substantive estimate implemented for each item in detailed. Each item from the bill of quantity sheet, which contain all activities will be done to execute such building. Each item in detailed is presented prior to construction. In the next lessons through this class, we'll clarify each method in detail separately, respectively. 3. ROUGH ORDER OF MAGNITUDE: Now, we'll start talking about the first method of price estimate analysis, which is called rough order of magnitude. It's typically used in the preparation and initiation phase of projects. For the development to project business case, for the determination of the required financial resources that are stated in the project charter. The rough order of magnitude method is typically used for project in the initiation phase with a high level of confusion and the uncertainty. With respect to the expected cost where, the required input data for the estimation technique may not be available at the time being. In other words, the available information is just a general idea of the project which was put forward by the owners. Of course, not sufficient to obtain the exact price of the project component. Because such information may be in the range of 1% to 5% only. The estimate value for this method is usually having a variance of negative 50% to positive 50%. It's to provide a rough estimate, of the total expenses that the owner may incur. until, the project is completed. An estimation approach known as top-down is mostly applied here. Whereas the overall project either estimated first, then individual task or allotted from it. or the project is broken down into larger tasks that are estimated separately. However, we may need it to get approximation and the estimated in general for the project price. And in that for the following reasons. First, for Feasibility studies in which you may need a total value only of the cost of establishing the project to enable the owner to make the right decision. Second choice, we may need it in the marketing for the project. Whereas there are some projects, especially residential or commercial, you may need to market them in advance. Sometimes the marketing team may request an initial price per square meter of the project based on which a marketing plan is drawing up and provide unit price to customers based on it. That For what? For the speed of presence in the real estate market to provide part of the cash needed to implement such a project. Now the question is, how we can do it? Actually, there are many different techniques , your team can choose. These techniques can be used individually or in combination with each other to arrive at a more accurate estimate. And in most cases, a project manager will need expert judgment and engage Technical Leads. So, what are the appropriate types of techniques could be implemented with the rough estimation? First technique called analogous estimation. Analogous estimation. This technique uses data and the knowledge of previous or similar project as the basis for estimating the new one will be an instance where the project manager is asked to give a duration and cost forecasts for new project. As the owner needs some data to decide whether the project is worth doing. In such cases, an analogous technique is the best solution. It's often used when. Much information about the project is not yet known. But, the accuracy of this approach is the lowest amongst the further techniques. However, it is the fastest and cheapest estimate to make. Getting data on a previous project is usually a few clicks away, especially if the project was done by your team. This estimation technique can be applied to the project as a whole and to the individual tasks of the project. But the pitfall of the analogous techniques when using this method, the project manager assumed is that all variables in the past project remained roughly the same for the new one. However, the variable, such as cost are constantly changing, which may lead to a significant deviation from the actual cost or duration of the project. So, to avoid such pitfalls as possible as we came. it is preferring to consider a percentage of the expected escalation of prices based on the periodical document issued by the official organization, organization or a governmental organization. For example. Previous similar project costs, maybe it was $15 thousand. To complete it in three months. Therefore, the new project should cost about $20 thousand. Why, we increase the value from 15 thousand to 20 thousand because we comparing the two project. Many different variables are taken into account such as scope, cost, inflation, duration, and so on. OK, The second technique could be implemented with Rough Estimation is the parametric technique. The parametric technique, makes use of cost unit tree taken from previous projects. And consider these rates for the assumed quantities in the new project to determine the estimated cost. For example, based on the master plan of the new project, we can assume the approximate quantities of the main tasks, such as the volume of concrete and the area of various finishing works. Then an initial estimate of the unit rate price of this item is made according to the prevailing market price or based on previous project data. So, we can estimate the cost for each major task. Therefore, by rolling up their estimated value, the whole project costs will be estimated. Actually, the accuracy of the parametric approach is quite more accurate than the analogous estimating because the parameter value are taken from several sources, like industry publications or similar projects which wide our search. and accordingly, our estimation be more accurate, but the same is a pitfall of the parametric techniques. The overall estimate is only as reliable as the parametric value. So, the accuracy of the project estimate maybe greatly skewed. If the parametric value is very small and the number of units is very large, or vice versa. For example, assume that estimate "A" equals $1 per unit and the quantity is 1 million unit. So, the total of estimate "A" is $1 million. Second estimate "B" the unit rate is $1000 per unit and the quantity is 1000 units. The total of estimate "B" is $1 million is the same like estimate "A" we see that even though the estimations are the same. A small mistake in the parametric value of estimate "A" will cause a significant increase in the value of the final estimate. However, that is not the case of estimate "B" because the unit rate is $1000, so any change will not impact aggressively on the total estimate would be. Another obvious drawback is that a parametric estimation required a lot of historic data which may not be available. We talked about two techniques to implement the rough estimation. The first is analogous and the second is parametric technique. Now, let's talk about the third technique could be implemented with the rough estimation, which is called a three-point estimation. Three-point technique uses optimistic, realistic, and pessimistic estimate to get the most accurate value for a project. The best thing about the three-point technique is its ability to accommodate for the uncertainty in project time. It also makes use of many of factors that can delay or accelerate the project's progress, Actually, by using the three-point technique, project manager can have an idea of the possible costs and the time variation for the deliveries and offer delivery dates to the stakeholder in a safer manner. What are the meaning of three-point, optimistic, realistic, and pessimistic. Optimistic. Assuming that low-risk use. Pessimistic, is assuming that the risks certainly accure. The most likely, is assuming the most realistic risk occurrence level, which already is the normal case. and to calculate the 3 estimate values. There are two accepted formula. First formula is the triangle distribution. It's simply the average of the three values commonly used in small, repetitive projects. In this case, estimated costs equals optimistic plus most likely plus pessimistic. The total divided by 3. Second formula is BETA distribution. This formula is also known as PERT, Program Evaluation and Review Technique. Which takes, the weighted average of the three values. So it's also known as a weighted average because the most likely value has four times more weight than the other two values. This technique is mostly used for large, non-repetitive project. and the estimated in this case equals the optimistic plus four times most likely plus pessimistic, the total divided by six. For example. Based on previous project, we understand that the time it takes to design the building under the best condition is 50 days. We then estimate the time it will take. If the worst-case scenario cues such as the expected missing of information or things like that. Let's say it's around 150 days. Then we assume that realistic time it will take to complete that task is 100 days. If some favorable and unfavorable scenarios is accused. So, the estimated time to design the building according to the three-point estimation technique. And based on BETA distribution formula will be expected time equals 50 days, which is an optimistic plus 4 multiplied by 100. 100 is the most likely plus 150 days, which represents the pessimistic expectation, the total divided by six equals 100 days. So the expected time for this task is 100 days. The pitfall of the three-point technique. This method will provide inaccurate estimates if there are inaccurate or incorrect assumption is scenarios. Also, it will be confusing and time-consuming if the optimistic, most likely and pessimistic values are defined by different people. So it should be decided by the same person to be involved in the all environment regarding this task. Now, and as a conclusion, the rough estimation method doesn't give much accuracy, but it's considered sufficient at this stage as it provides at least a rough idea of the cost range of project, which is often useful for the purpose of stakeholder communications in an early stage. And can also be used to develop a budget business case or a project charter. And, the common techniques followed to implement such method are analogous technique, parametric technique, and three-point technique. And definitely. These techniques can be used individually or in combination with each other to arrive at a more accurate estimation. 4. PRILIMINARY ESTIMATION METHOD: The second method of studying project price estimate is called the preliminary estimation, also called the budget level estimate. This type of estimate is used to aid in decision to choose among the various options available. Options for the final product. Its features and configurations are analyzed and the estimated to make a decision to proceed with one alternatives, over the others. Hence, the estimate needs only to be as detailed as necessary to distinguish between alternatives. This method is applicable when the project definition level is about 10 to 40%, which is considered sufficient to determine the type of main item in the project. This information is almost obtained through schematic design, in which it becomes clear, the shape of the general building, and the nature of material used in construction, which has freed us with the necessary information. Like the type of skeleton and if it concrete material or metal structure or something else, it provide also the number of floors and the built-up area for each one. the different types of finishing work. And the types of electromechanical system will be used. Based on such information, we begin to analyze each main item separately. Definitely, we can follow the parametric technique in our analysis for the preliminary estimation by counting the approximate quantities from the available initial design drawings and then determining the expected cost for each main item depending on the prevailing prices in the market or previous project. Additionally, we can improve the accuracy of our results by using a three-point technique in combination with the parametric technique to accommodate for the uncertainty in Project times accordingly and in submission of the estimated value for the major items, we can get the total cost of the project. The difference between this method compared to the rough method noted in terms of relatively increase the accuracy in calculating the total cost of the project as it was relied on evaluating the cost of the mian items separately. And therefore, the error rate in estimating the price will be much less due to the limited search space compared to the rough method. In addition, in this method, we have separate initial prices for each main item, which facilitates the process of comparing the different alternatives. how that come ?. Actually, this method is used by the owner in the event that he wanted to obtain several alternatives to the method of implementing the project. Where the alternatives are multiple, especially in the infrastructure and roads projects in which changing the path of Road works or method of excavation work for mechanical pipes underground may have a significant impact on the differences in project value. Therefore, it's better to analyze the main task only to clarify the difference in cost and in which main task specifically to facilitate decision-making regarding suitable alternative. Finally, based on the methodology of this method is the expected error rate in the study ranging from minus 10% to positive 25%. And it's clear that the positive percentage is greater, in which we always assume the quantities for the higher value is a factor of safety in our cost estimation. 5. SUBSTANTIVE ESTIMATION METHOD: The third method to estimate the project price is the exact method, which is called also Substantive Method. In this way, all project information became available. And this information is represented in full design drawings, technical specification and the contractual terms. Before describing the process of the substantive method or the detailed cost estimation for project. It wise to take a look at the various cost categories associated with the project and its relation to the bid price. This figure shows the main components of a bid price, which is being direct costs. Indirect costs, and markup. In substantive method, we will analyze and estimate the cost of each component, which in total produce the contract sale price. Actually several classifications of cost are in common usage, like fixed, variable and semi-variable is a basic economic classification. But in the context of the construction industry, the classification of costs are direct cost and indirect cost is more widely used and understood. Indeed, it's upon such a classification. Most tenders are prepared by contractors. How we can do it? First, let's talk about direct costs. Direct Costs are the costs attributed to the production of activities of a project, which represent about 60% from the sell price. They are estimated based on detailed analysis of the resources, productivity data and the method of construction being used for every activity. The direct costs are the summation of the cost of the labor, equipment, crews, materials and subcontractors used in all the activities in our project. By determining the required quantity of each cost element that required to implement it, this item or this activity. And that based on the available information through design drawings and the technical specification for the implementation of such item. Then, the price of each cost element is determined according to a quotation from sources of supply or implementation of cost element. And these sources may be suppliers of the material used or from subcontractors. Second component, is the indirect cost. Actually, this costs are consisted of two categories, project overheads and general overhead. Project overhead, which represent about 25% of bid sell price. This include a cost of items which cannot be directly charged. to specific work's element. This includes the cost of utilities, permits, supervision, and so on. Which service many elements in the projects work breakdown structure. The general overhead which represent about 5% of bid sell price. These are costs that cannot be directly attributed to a single project and include items such a head office expenses, taxes, and so on. The current project’s share. Of these costs can be estimated to be proportional to the project value as compared to the total yearly volume of the contractors organization. Finally, the markup. This bid components represent the contractors the added fees as a percentage of direct plus indirect costs. That covers two aspects. First, the profit, that depending on the business objectives, of the contractor organization, this item can be decided based on the level of computation and the contractual or contractor needs for winning this particular project. The second, for the Risk of contingency, which is used to provide safeguard against uncertain circumstance that are anticipated to affect the project, such as weather, labor problems, soil conditions, any changes. and so on. And the percentage of markup, it's around 5% from the sell price. Now, after we clarified the three method of estimation, rough order of magnitude a preliminary estimate and substantive estimate. It's worth noting that there is another method, but it's not commonly used, is called the definitive method. In this method, the contractor tries to avoid completely the error rate in pricing by concluding prior contracts with subcontractors to implement the work in full So, that all the responsibilities and obligations of the main contract are transferred to the subcontractors, thus avoiding any risk from the possibility of changing prices. Since in this case, the value of the project cost will be fixed and known before starting the project and the equal to the value of the previous concluded contract, contracts of subcontractors. But, definitely in this case is the main contractor. We lose part of his plan profit, which will be transferred directly to the subcontractors carrying out the project. Therefore, this method is used only in special cases in which the probability of price change may be large or the main objective obtaining this project is to increase the volume of business for the main contractor and not to profit. Thank you, and hope to see you soon in my next class about the tender document. see you later