Wednesday, April 22, 2009

An Old Question Revisited: How do you manage cost?

I was asked recently in a way that begged for an 'elevator speech' reply: "How do you manage cost?" My goodness! How much time do I have to reply? Isn't that question even older than project management itself? Is there any more to be said?

The best way to answer is to have a conversation, because the response is all tied up in values: is cost the dominant leg in the cost-schedule-scope-quality trade space? Or, is the proposition to always manage to a 'best-value' formulation? If value is what we are willing to pay for, then presumably best-value is also lowest-buck for what we get, but it may not be the lowest cost solution for the minimum requirements. So, we need to get the value thing decided straight away.

The mistake most made is to manage cost like it is an input, rather than a result. Managing at the input means watching the cash flow in comparison to the budget plan for cash consumption. This will provide comfort to the CFO, but it does little for the other stakeholders. The cash flow could be right on plan, cash consumed exactly as planned, and yet the project could be churning pointlessly and producing nothing. There is no value proposition at the input, so continuing to focus on the input side of the project process is strictly a CFO task.

Value is produced at the output. By now, everyone should know this. To manage cost is to manage three variables: budgeted cash flow at the input, actual cost in the process, and value of the actual outcomes.

> The budget is managed with the requirements process and the estimating skills of the team. Each of these, the requirements and estimates, are independent sources of error, and then there are co-variances between them that stretch the errors.

> The actual cost is managed by attention to effective practices, efficient procedures, and look-ahead risk management. Effectiveness is a measure of impact, efficiency is a measure of effort to produce impact, and risk management is foreseeing problems in time to reduce their impact
> Value is managed by insisting on an outcome that meets the quality standards of the stakeholders, but does not overreach on attributes that aren't valuable, to wit: better is the enemy of good!

If you are into an earned value management mind-set, then you recognize the EVM concepts in the foregoing:
> the budgeted cost of the work scheduled, aka BCWS, aka the Budget or Planned Value [PV],
> the actual cost of the work performed, aka ACWP, aka Actual Cost [AC], and
> the budgeted cost of the work performed, aka BCWP, aka Earned value [EV].

There are several ratios and other formulas that you can make out of these four parameters to explain history and forecast the future, but the one that is missing from all the EVM systems is AC/PV. This is the infamous input view we spoke of before. It carries no value; it only measures adherence to a spending plan.

By the way, forecasts are the weakest link! Does history ever repeat? Milton Friedman, distinguished economist, opined: "if you are going to predict, then predict often!" Meaning: hey, things change.

It's a lucky project manager that actually gets to control the labor AC to only that which is needed to produce the EV. This is another of those conversations we need to have. How many times have people been placed on projects because they would otherwise be on overhead and vulnerable to release? How many times have people been retained on projects, the so-called marching army, because PM's have been told they can't get them back if they release them? Smart management anticipates labor redundancies, but also labor losses that might impact the EV: vacation, sick leave, other duties as assigned!

It's a lucky project manager that actually controls the overhead expenses of their project. In point of fact, many projects are encumbered with liquidating enterprise expenses disproportionately to use. It's part of the game, so smart cost managers anticipate the impact of changing overhead positions.

Now the challenge remains to get this all into 30 seconds so that it will sound good on the elevator!

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