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Paper P1 Performance Operations

ENTERPRISE MANAGEMENT
How many projects have you heard about that have bust their budgets? Far too many, no doubt, compared with the number that you can recall coming in well within budget. A comprehensive study of projects in 2003 found that nine out of 10 had gone over budget and that overruns of 50 to 100 per cent were typical. Cost overruns are particularly common in construction and technology projects. Research into IT projects in 2004 found that seven out of 10 had overspent and missed their target completion dates. The average cost overrun was 43 per cent. Some of the more spectacular and welldocumented cases of project overspending include the development of supersonic airliner Concorde, which had a 1,100 per cent overrun, and the construction of

Dave Rochford offers tips on reducing project costs and preventing overruns.
Sydney Opera House, which exceeded its budget by 1,400 per cent. Some of the more obvious causes of cost overruns are as follows: Poorly defined requirements and a lack of agreement and prioritisation. Scope creep eg, the uncontrolled addition of extra requirements. Inappropriate designs. Inadequate information. Unforeseen problems. A lack of control on spending. Insufficient skills and resources. Inadequate checks on estimates and work. Poor project direction and management. Some less obvious causes include: The absence of a robust business case. A lack of understanding about cost drivers and direct and indirect costs. The insufficient use of planning techniques. Poor estimation or forecasting, especially of demand and revenue. A lack of option appraisal or evaluation of cheaper alternatives. In-built complexity and delays. Poorly integrated plans and an imbalance between people and processes. An inadequate consideration of safety, legal, regulatory and environmental issues. A lack of formal agreements where there is a dependence on third parties. The existence of political pressure, vested interests or a fear of a lack of approval. The Sydney Opera House project went over budget largely because construction was pushed ahead by the government before all the technical design problems were solved, which led to significant reworking and rebuilding. The associated cost increases

Cost-duration graph
Direct cost 90 80 70 Cost ($000) 60 50 40 30 20 10 0 5 6 7 8 9 10 11 12 13 14 15 Duration of project (weeks) Lowest total project cost Indirect cost Total cost

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nancial management

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PAPER E2

resulted in the architects resignation and further delays. The building was eventually completed a full decade later than scheduled. The Concorde project overran mainly because of political reasons, too. Duplicate assembly lines were established by the French and UK governments and the finished product a particularly costly aircraft to operate was bought only by the two countries state airlines. While such factors may be beyond the control of a single project manager, you can still use several tools and techniques to help control costs. The first step in preventing overruns is to acknowledge that they are likely. The risk should be managed by: setting up the project properly; ensuring that there is a sound business case with realistic estimates of costs and revenues; and understanding and analysing the cost drivers and costs, both direct and indirect. Setting up the project properly will help to avert unforeseen problems and knock-on effects later. Using accepted methods such as PRINCE2 will help you here, but the following key ingredients are required: A project brief with clearly defined objectives and responsibilities. A detailed, integrated project plan with discrete, manageable stages and an agreed schedule for resource allocation. Defined processes for identifying and managing risks, problems, assumptions, dependencies, decisions and changes. Its important to factor in leadership, stakeholder and risk management issues at an early stage and discuss them openly at meetings of the project board or steering group. A supportive organisational culture should help to prevent problems from being discussed behind closed doors. The business case drives the project. It should be seen as a living model for delivering continuous benefits, not as a oneoff exercise to obtain funding. Business cases must be detailed yet easily understandable,

with costs and benefits itemised and the forecast ROI signed off by the finance team. Its important to make realistic cost estimates, which ideally should be based on experience or benchmarked and validated using a range of sources. At this point its useful to distinguish between direct and indirect costs. The former can be assigned to a specific package of work or activity eg, labour or materials. The latter cannot be associated with any particular work package or activity eg, admin and interest payments. Once the direct and indirect costs and drivers have been identified, you can prepare a costduration graph (see panel, opposite page). This will inform scheduling decisions and enable sensitivity analysis to assess critical activities and costs. When assessing and reviewing costs, you need to do the following: Identify the lowest-cost activities that could reduce the projects duration and cost. Compute the costs and benefits of reducing the projects duration. Shortening the project may cut the indirect costs but it may also increase the direct costs if it means that more resources are needed. Explore and assess options eg, using internal, rather than external, resources. Assess the impact of possible problems and build in a contingency factor. A projects budgeted costs should always include a contingency fund. You should focus on what adds value to the project. Dont ignore the benefits, since they can often alleviate the effects of cost increases. Cutting expenditure may not be the answer, therefore, because this could reduce all the value in the project. It is also important to establish agreed baselines of performance from which benefits can be measured. Where possible, you should tie these to costs to inform decisions on the projects scope and priorities. Spending time on benefit assessment can help you to improve the viability of the project

and identify further potential benefits as well as early achievements that help to increase peoples commitment to the project. But calculating benefits and forecasting revenue isnt as straightforward as it might seem. In their book Megaprojects and Risks (Cambridge University Press, 2003), Bent Flyvbjerg, Nils Bruzelius and Werner Rothengatter argue that its dangerous to rely on revenue forecasts, which tend to be inaccurate. They suggest that theres a need for institutional checks and balances; performance specifications; penalties for estimation errors; and the use of risk capital to encourage more accurate forecasting. While I have focused here on the financial side of managing project costs, you should not forget that they are run by people, so stakeholder analysis, governance and communication are equally important factors. Dave Rochford FCMA is an independent consultant, writer and lecturer.

Ten ways to control the costs of a project

Clearly define and prioritise the projects requirements. Identify the direct and indirect costs, and the main cost drivers and dependencies, understanding the cost-time relationships. Validate forecasts and estimates. Match the costs and benefits, linking them to objectives. Optimise the cost/benefit ratios and ensure that accountability is matched with responsibility. Reduce the scope of the project where little added value is evident. Consider lower-cost alternatives. Focus on the most crucial activities. Use cross-functional teams to tackle problems. Continually seek alternative ways to meet deadlines.

ALAMY

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