INF337 Week 3 discussion 1

Describe the linkages of the work breakdown structure and the time-phased budget to arrive at an earned value analysis. What is the impact on earned value if the cost estimation is significantly lower because of low estimates or specification changes in the project? Provide examples of projects you have been involved with or read about that may have had this problem. Respond to at least two of your classmates’ postings.Resource is attached
wiley_cost_and_value_management.pdf

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COST AND VALUE
MANAGEMENT
IN PROJECTS
Ray R. Venkataraman and Jeffrey K. Pinto
John Wiley & Sons, Inc.
This book is printed on acid-free paper.
Copyright ? 2008 by John Wiley & Sons, Inc. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
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Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their
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Library of Congress Cataloging-in-Publication Data:
Venkataraman, Ray R.
Cost and value management in projects / Ray R. Venkataraman and Jeffrey K.
Pinto.
p. cm.
Includes bibliographical references and index.
ISBN 978-0-470-06913-4 (cloth)
1. Project management. 2. Cost control. 3. Value analysis (Cost control)
I. Pinto, Jeffrey K. II. Title.
HD69.P75V46 2008
658.4 04—dc22a
2007024563
Printed in the United States of America.
10 9 8 7 6 5 4 3 2 1
Contents
1
Introduction to the Challenge of Cost and Value
Management in Projects
1
1.1
2
Importance of Cost and Value Management
in Projects
1.2
Keys to Effective Project Cost Management
1.3
Essential Features of Project Value Management
1.4
Organization of the Book
References
2
6
8
9
14
Project Needs Assessment, Concept Development,
and Planning
17
2.1
2.2
2.3
2.4
2.5
3
Needs Identification
Conceptual Development
The Statement of Work
Project Planning
Project Scope Definition
2.5.1 Purpose of the Scope Definition Document
2.5.2 Elements of the Scope Definition Document
2.5.3 Project Scope Changes
2.6
Work Breakdown Structure
2.6.1 Types of Work Breakdown Structures
2.6.2 Work Breakdown Structure Development
2.6.3 Coding of Work Breakdown Structures
2.6.4 Integrating the WBS and the Organization
2.6.5 Guidelines for Developing a Work Breakdown
Structure
References
19
22
23
27
28
29
29
30
32
34
35
38
38
Cost Estimation
43
3.1
3.2
44
45
Importance of Cost Estimation
Problems of Cost Estimation
v
42
42
vi
4
Contents
3.3
3.4
3.5
Sources and Categories of Project Costs
Cost Estimating Methods
Cost Estimation Process
3.5.1 Creating the Detailed Estimate
3.6
Allowances for Contingencies in Cost Estimation
3.7
The Use of Learning Curves in Cost Estimation
References
Appendix
49
51
56
56
59
61
64
67
Project Budgeting
83
4.1
4.2
83
85
85
85
86
86
87
88
89
90
90
90
91
91
92
93
93
94
95
95
96
97
98
99
Issues in Project Budgeting
Developing a Project Budget
4.2.1 Issues in Creating a Project Budget
4.3
Approaches to Developing a Project Budget
4.3.1 Top-down Budgeting
Top-down Budgeting: Advantages
Top-down Budgeting: Disadvantages
4.3.2 Bottom-up Budgeting
Bottom-up Budgeting: Advantages
Bottom-up Budgeting: Disadvantages
4.4
Activity-based Costing
4.4.1 Steps in Activity-based Costing
4.4.2 Cost Drivers in Activity-based Costing
4.4.3 Sample Project Budget 1
4.4.4 Sample Project Budget 2
4.5
Program Budgeting
4.5.1 Time-phased Budgets
4.5.2 Tracking Chart
4.6
Developing a Project Contingency Budget
4.6.1 Allocation of Contingency Funds
4.6.2 Drawbacks of Contingency Funding
4.6.3 Advantages of Contingency Funding
4.7
Issues in Budget Development
4.8
Crashing the Project: Budget Effects
Crashing Project Activities—Decision
Making
References
100
104
Contents
5
Project Cost Control
Overview of the Project Evaluation
and Control System
5.1.1 Project Control Process
5.2
Integrating Cost and Time in Monitoring Project
Performance: The S-Curve
5.3
Earned Value Management
5.4
Earned Value Management Model
5.5
Fundamentals of Earned Value
5.6
EVM Terminology
5.7
Relevancy of Earned Value Management
5.8
Conducting an Earned Value Analysis
5.9
Performing an Earned Value Assessment
5.10 Managing a Portfolio of Projects with Earned Value
Management
5.11 Important Issues in the Effective Use of Earned
Value Management
References
vii
105
5.1
6
Cash Flow Management
105
106
107
111
112
114
114
115
117
119
122
123
126
127
6.1
6.2
The Concept of Cash Flow
127
Cash Flow and the Worth of Projects
131
6.2.1 The Time Value of Money, and Techniques for
Determining It
132
6.2.2 Applying Discounting to Project Cash Flow
134
6.3
Payment Arrangements
137
6.3.1 Cost-reimbursable Arrangements
138
6.3.2 Payment Plans
140
6.3.3 Claims and Variations
142
6.3.4 Cost Variation Due to Inflation and Exchange Rate
Fluctuation
144
6.3.5 Price Incentives
145
6.3.6 Retentions
146
References
148
7
Financial Management in Projects
7.1
7.2
Financing of Projects Versus Project Finance
Principles of Financing Projects
149
149
150
viii
Contents
7.3
7.4
7.5
7.6
7.7
Types and Sources of Finance
Sources of Finance
Cost of Financing
Project Finance
The Process of Project Financial Management
7.7.1 Conducting Feasibility Studies
7.7.2 Planning the Project Finance
7.7.3 Arranging the Financial Package
7.7.4 Controlling the Financial Package
7.7.5 Controlling Financial Risk
7.7.6 Options Models
References
8
Value Management
8.1
8.2
8.3
Concept of Value
Dimensions and Measures of Value
Overview of Value Management
8.3.1 Definition
8.3.2 Scope
8.3.3 Key Principles of VM
8.3.4 Key Attributes of VM
8.4
Value Management Terms
8.5
Need for Value Management in Projects
8.6
The Value Management Approach
8.6.1 Cross-functional Framework
8.6.2 Use of Functions
8.6.3 Structured Decision Process
8.7
The VM Process
8.8
Benefits of Value Management
8.9
Other VM Requirements
8.10 Value Management Reviews
8.11 Relationship between Project Value and Risk
8.12 Value Management as an Aid to Risk Assessment
8.13 An Example of How VM and Risk Management
Interrelate
References
9
Change Control and Configuration Management
9.1
9.2
Causes of Changes
Influence of Changes
151
153
153
154
156
156
156
157
157
158
159
161
163
163
166
167
168
168
168
169
169
171
171
172
172
172
173
175
175
176
180
181
182
184
185
186
190
Contents
9.3
9.4
9.5
9.6
9.7
Configuration Management
Configuration Management Standards
The CM Process
Control of Changes
Change Control Procedure and Configuration
Control
9.8
Responsibility for the Control of Changes
9.9
Crisis Management
9.10 An Example of Configuration Management
References
10 Supply Chain Management
10.1
10.2
10.3
10.4
What Is Supply Chain Management?
The Need to Manage Supply Chains
SCM Benefits
Critical Areas of SCM
10.4.1 Customers
10.4.2 Suppliers
10.4.3 Design and Operations
10.4.4 Logistics
10.4.5 Inventory
10.5 SCM Issues in Project Management
10.6 Value Drivers in Project Supply Chain Management
10.7 Optimizing Value in Project Supply Chains
10.7.1 Total Quality Management
10.7.2 Choosing the Right Supply Chain
10.8 Project Supply Chain Process Framework
10.8.1 Procurement
Supply Chain Relationships
Supplier Development
10.8.2 Conversion
10.8.3 Delivery
10.9 Integrating the Supply Chain
10.10 Performance Metrics in Project Supply
Chain Management
10.11 Project Supply Chain Metrics and the Supply
Chain Operations Reference (SCOR) Model
10.12 Future Issues in Project Supply Chain Management
References
ix
191
192
193
196
197
200
201
202
206
209
210
211
212
213
213
213
214
214
215
215
217
220
220
221
221
221
223
224
224
225
225
227
230
231
232
x
Contents
11 Quality Management in Projects
11.1
11.2
Definition of Quality in Projects
Elements of Project Quality
11.2.1 The Project’s Product
Quality Engineering
11.2.2 Management Processes
11.2.3 Quality Planning
11.2.4 Quality Assurance (QA)
11.2.5 Quality Control
11.2.6 Corporate Culture
11.3 Total Quality Management (TQM) in Projects
11.4 Quality Management Methods for a Project
Organization
11.4.1 The Six Sigma Methodology
11.4.2 The Six Sigma Model for Projects
11.4.3 Application of Six Sigma in Software Project
Management
11.5 Quality Standards for Projects
References
12 Integrating Cost and Value in Projects
12.1
12.2
12.3
The Project Value Chain
Project Value Chain Analysis
Sources and Strategies for Integrating Cost
and Value in Projects
12.3.1 The Project’s Inbound Supply Chain
12.3.2 Project Design
12.3.3 Project Development
12.3.4 Project Delivery/Implementation
Life-cycle Costing
12.3.5 Costs of Project Life Cycle Employing the LCC
Model
12.4 Integrated Value and Risk Management
12.5 The Project Cost and Value Integration Process
References
Index
235
235
237
238
239
243
243
244
245
245
245
247
249
250
252
252
253
255
255
257
259
260
260
265
267
268
271
272
274
277
279
Chapter 1
Introduction to the Challenge of Cost
and Value Management in Projects
The past 30 years have witnessed a dramatic increase in the number
and variety of organizations engaged in project-based work. In addition
to ‘‘traditional’’ project-oriented industries, like construction, aerospace,
and pharmaceuticals, service industries as diverse as finance, utilities,
telecommunications, and insurance are beginning to embrace projectbased ventures.
This paradigm shift is due to growing recognition that projects and
their effective management can provide organizations with a significant
competitive edge through cost reduction, enhanced responsiveness, and
overall value to customers. Consequently, a number of organizations have
adopted many of the well-known techniques of project management, and
professional project management organizations have witnessed marked
increases in membership.
Despite this enormous interest in projects and project management
practices, success rates in many industries are at alarmingly low levels.
In addition, bad news about high-profile projects continues to dominate
the headlines— in both the public and private sectors. Consider these
recent examples:
London’s Costs for 2012 Soar. A British parliamentary committee
criticized the spiraling costs of the 2012 London Olympics and called
for greater transparency on finances. In November, Olympics Minister
Tessa Jowell said infrastructure costs had risen by $1.8 billion from
the $4.7 billion figure quoted in the bid. Some British lawmakers have
speculated the total cost could reach more than $15.9 billion.1
Cost and Value Management in Projects. Ray R. Venkataraman and Jeffrey K. Pinto
Copyright ? 2008 John Wiley & Sons, Inc.
2
COST AND VALUE MANAGEMENT IN PROJECTS
Lockheed Gets Navy Warning Shot. The Navy on Friday said it
ordered Lockheed to stop work on the new coastal-waters warship
because of big cost overruns. Construction on the first ship will continue,
but the second Lockheed Martin ship is on hold and subject to a 90-day
stop-work order. The Navy didn’t disclose the size of the cost increase,
but the Lockheed Martin ship now is expected to cost $320 million or
more. The ships are supposed to cost $220 million each once they are
in production. The Navy acknowledged last year that the lead ships for
each of two designs was more likely to cost on the order of $300 million
each.2
Clearly, something is going wrong.
1.1
IMPORTANCE OF COST AND VALUE
MANAGEMENT IN PROJECTS
The key features that define project success are twofold: managing
costs to achieve efficiencies, and creating and enhancing value. These
two elements enable project stakeholders to understand the activities
and resources required to meet project goals, as well as the expenditures necessary to complete the project to the satisfaction of the
customer.
Unfortunately, in the field of project management today, significant
cost and schedule overruns are the norm, rather than the exception.
In fact, recent research that examined the success rates of information
technology (IT) projects indicates that the majority of these projects
neither met their cost objectives nor delivered the promised value. For
example:
•
In a study of 300 large companies, consulting firm Peat Marwick
found that 65 percent of hardware and/or software development
projects were significantly behind schedule, were over budget, or
failed to deliver value in terms of expected performance.3
• In a report on the current state of IT project implementation, the
Standish Group predicted that out of a total of 300,000 projects that
cost over $350 billion, approximately 43 percent will overshoot their
initial cost estimates, while 63 percent will fall behind schedule and
perform at only two-thirds of their expected capability.4 In other
words, these projects will meet neither their cost nor their value
objectives.
Importance of Cost and Value Management in Projects
3
Why do these problems persist, despite the fact that tools for cost efficiency
and value enhancement are widely used, and their benefits are well
understood? One key answer is the lack of an integrated cost and value
management framework.
Before we explore this integration of cost and value, a brief discussion
of their concepts in relationship to projects is worthwhile. Both require
well-defined and structured management processes, commonly referred to
as cost and value management. Project cost management focuses on issues
such as cost estimation and budgeting, cash flow management, and cost
control. On the other hand, the emphasis of value management is on optimizing project value—given cost, time, and resource constraints—while
meeting performance requirements such as functionality and quality.
Cost and value management remains a critical but often underrepresented issue for a couple of reasons. First, in this book, we define value
as the relationship between meeting or exceeding the expectations of
project stakeholders, as well as the resources expended to meet or exceed
those expectations. This definition clearly implies that project cost and
value are inextricably linked, to the point where any attempt to enhance
project value without a thorough understanding of its impact on cost and
associated trade-offs is meaningless.
Second, project value is a multidimensional concept. Different project
stakeholders with different vested interests have different perceptions
about what constitutes value to them. For example, the expectations of
top management often leave IT project teams scrambling to complete
projects as quickly as possible. Internal customers, however, may request
additional features that will delay completion. Each stakeholder sees
value in the finished project; however, the measures they use to determine
value can actually conflict. And yet, despite these differences, the one
constant in any attempt to enhance project value is its cost ramifications.
The inability to clearly understand this complex relationship between
project cost and value is one of the primary reasons why it is an underrepresented issue. The following case example illustrates this point.
Case Study: Boston’s Central Artery/Tunnel Project
The Central Artery highway in Boston was first opened in 1959 with considerable fanfare. Hailed as a technical marvel and model of proactive urban
planning, the elevated six-lane highway was designed through the middle of
4
COST AND VALUE MANAGEMENT IN PROJECTS
the city and was intended to handle a traffic volume of 75,000 vehicles a day.
However, by the early 1980s, the highway was overburdened by a daily volume of over 200,000 vehicles. Consequently, the city of Boston experienced
some of the worst traffic congestion in the country, with bumper-to-bumper
traffic that lasted for over 10 hours every day. The traffic woes of the Central
Artery highway were further exasperated by an accident rate that was over
four times the national average. Clearly, the Central Artery had not only
become inadequate to handle the city of Boston’s growing traffic volume,
but had also become one of the most dangerous stretches of highway in the
country.
To alleviate the problem, the City of Boston, under the supervision of
the Massachusetts Turnpike Authority and with the help of Federal and
State funding, came up with the Central Artery/Tunnel (CA/T) project, more
commonly referred to in the Boston area as the ‘‘Big Dig.’’ The two main
features of the CA/T project are (1) an eight- to ten-lane underground
expressway replacing the old elevated roadway, with a 14-lane, two-bridge
crossing of the Charles River; and (2) extension of I-90 by building a tunnel
that runs beneath South Boston and the harbor to Logan Airport. The CA/T
project that began in the city in the early 1980s has been a work in progress
for nearly 20 years.
From the outset, the CA/T project faced enormous technical and logistic
challenges. First, the project involved construction of eight miles of highway
with a total of 161 lane miles, with almost half them to be constructed
underground. The project at its peak required 5,000 workers, excavation of
16 million cubic yards of soil, and 3.8 million cubic yards of concrete. Second,
all of these construction activities had to be performed without disrupting
existing traffic patterns, the current highway system, and its traffic flows.
The project began in 1983 with an original completion date of 1998
and a budget of $2.5 billion. However, neither the original budget nor
the completion date has been met, and both have been revised upward
frequently. For example, the original budget of $2.5 billion was adjusted to
$6.44 billion in 1992, and $14.63 billion in 2003.
Because of the soaring cost projections and schedule overruns, the CA/T
project has been source of considerable controversy. The situation was
so bad that in 2000 a Federal audit of the project declared the Big Dig
officially bankrupt. One of the audit’s significant conclusions was that the
out-of-control costs were due primarily to management’s failure to hold
contractors accountable for bids or mistakes. In fact, the public dissatisfaction
over the delays and rising costs was so intense that the project manager of
CA/T project had to resign. After more than 14 years of construction, the
CA/T project was officially declared completed in the spring of 2006, in spite of
the fact that some finishing work still remained. All of the tunnels and bridges
and their connections and ramps to surface roads were opened to the public.
Importance of Cost and Value Management in Projects
5
Unfortunately, the story does not end there. On July 10, 2006, the bolts
holding four sections of cement ceiling panels (weighing 12 tons) failed,
causing a section to collapse onto traffic below …
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