How to Estimate Project Costs: A Method for Cost Estimation

Main ideas / lessons conveyed

• Cost estimation is difficult in project environments due to bias and uncertainty.
• Project managers must constantly balance two opposing pressures:
  • “Pull” to minimize: reduce cost and duration to satisfy clients, bosses, sponsors, and stakeholders.
  • “Pull” to increase: include more contingency, cost, and time to reduce the likelihood of overruns and improve delivery reliability.
• Effective estimation begins with a clear understanding of scope, then builds the cost estimate from structured work and resources.
• Estimates should be robust, not a one-time effort—use multiple techniques and challenge mechanisms.
• Contingency should be nuanced (by work stream and uncertainty level), not a single flat number.
• After estimating costs and contingency, convert them into a cash flow to support financial planning and business-case development, including discounted cash flow for long projects.
• Ultimately, a strong estimate enables a business case that compares total estimated costs to expected benefits.

Methodology / process steps (detailed)

1. Start with scope using a Work Breakdown Structure (WBS)

   • Build a WBS to define the components of the work.

2. Estimate time for each WBS component

   • For each component, estimate the time required to deliver it.

3. Assign resources based on roles

   • Allocate people/roles to work components based on estimated time needs.

4. Build up direct labor/resource cost

   • Combine required time with resource cost rates to begin forming the estimate.

5. Overlay additional required inputs per work component

   • For each piece of work, add:
     • Materials
     • Equipment
     • Assets

6. Use a Work Breakdown Structure → Cost Breakdown Structure approach

   • Convert the WBS into a Cost Breakdown Structure (CBS) to capture costs systematically.

7. Identify likely cost sources to include

   • People costs (staff, contractors, consultants)
     • Note: some organizations treat internal staff cost as “sunk”; the speaker recommends calculating it for a true picture of project cost.
   • Real estate / property / facilities / offices / warehousing
     • Decide whether to treat as capital costs or revenue costs (e.g., leasing/hiring).
   • Non-capital / revenue costs
     • Such as materials and components
   • Licensing
     • Especially software licenses (including tools and parts of what you’re creating)
   • Financing costs
     • Such as interest, foreign exchange, and insurance

8. Apply estimating techniques (six methods)

   1. Order of magnitude estimate - Start with big chunks and produce round figures (e.g., hundreds of thousands vs. thousands depending on whether the project is millions vs. tens of thousands). - Purpose: gauge project size and determine the required level of detail.
   2. Reference class forecasting - Use past/comparable projects to estimate cost. - Adjust for systemic differences, especially inflation (e.g., $100k ten years ago likely costs more today).
   3. Parametric forecasting (“rule of thumb forecasting”) - Use measurable relationships (e.g., worker productivity × total quantity). - Example logic: - If 1 worker lays 100 bricks/hour and 200,000 bricks are needed: - Compute total hours - Compute number of people needed given time constraints - Multiply by daily rates to estimate labor cost
   4. Bids/tenders - Request pricing from providers and use bids as the basis. - Even with fixed-price bids, include assumptions/contingency because: - bids may depend on interpretations, - contract variations can arise.
   5. Catalogs and pricing tables - Use published pricing data as inputs, especially alongside parametric methods.
   6. Sample/test/pilot/prototype - Calculate actual cost on a smaller trial and use it to inform full-scale production/implementation.

9. Combine methods for better robustness

   • Use as many techniques as practical to improve reliability of the final estimate.

10. Validate estimates using a “red team”

    • Use a separate team to:
      • “tear apart” (review critically), or
      • build a parallel estimate using different methods and perspectives.
    • Compare outputs to learn why teams reached different answers and improve the estimate.

11. Add contingency correctly (work-stream specific)

    • Add contingency always, but not as one flat number.
    • Instead:
      • Break the project into work streams / functional components / phases
      • Assess uncertainty level for each
      • Apply different contingency percentages, e.g.:
        • 10% for familiar, well-understood work/technology
        • 40% for unfamiliar work (not off-the-shelf; done for the first time)
    • Combine the resulting contingencies to get a robust overall project contingency.

12. Convert estimate into cash flow

    • Build a cash flow schedule showing when costs (and possibly revenues) occur over time.

13. Use discounted cash flow for long projects

    • If the project is long:
      • apply effects of interest and inflation
      • use discounted cash flow techniques.

14. Use estimates to build the business case

    • Business case = comparison:
      • estimated total costs
      • vs. total benefits (benefits are a separate exercise).

Speakers / sources featured

• Speaker: Not explicitly identified in the subtitles (only referred to as “in this video” / the presenter).
• Other sources: None explicitly named or cited beyond generic references to:
  • clients, bosses, sponsors, stakeholders
  • organizations/providers bidding/tendering
  • published catalogs/pricing tables
  • the “red team” (an internal validation concept, not a named group)
  • a separate video referenced: “what is a discounted cash flow” (no author/channel name provided).