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Facts At Your Fingertips Cost Estimation and

Risk

Department Editor: Scott Jenkins

nderstanding project risks is TABLE 1. AACEI ESTIMATE CLASSES, DELIVERABLE STATUS AND RANGE-OF-RANGES critical to arriving at useful cost Range of ranges estimates. Since each capital Low end (plO) AACE Class Key deliverable status High end (p90) project in the chemical process in­ Class 5 Block How agreed upon by stakeholders -50 to-20% +30 to+100% dustries (CPI) is somewhat unique, Class 4 Process flow diagrams issued for design -30 to-15% +20 to+50% it can be difficult for engineers and project leaders to price risks in their Process and instrumentation diagrams issued -20 to-10% +10 to+30% Class 3 for design estimates and project budgets. This one-page reference provides infor­ Class 2 All specifications and datasheets complete -15 to-5% +5 to+15% mation on project risk, contingency Most or all engineering and design work complete Class i +3 to+15% -10 to-3% and accuracy in cost estimation. level of scope definition. Since the Cost estimates include two main (or deflation) is a component of this. Accuracy range. An expression of 1990s, almost every major CPI owner parts: the “base," which encom­ passes the risk-free costs, other than an estimate's predicted closeness to company has implemented a phasegate project system, and the phases specific allowances, and the "risks,” final actual costs or time. Typically ex­ which include contingency, reserves, pressed as high or low percentages by usually line up with the Association for which actual results will be over and un­ the Advancement of Cost Engineer­ escalation and currency exchange. der the estimate (base or funded), along ing (AACE) International (Morgan­ Definition of terms with the confidence interval that these town, W.Va.; www.aacei.org) AACE The following terminology is associ­ Estimate Classes (Table 1). Other key percentages represent. risk drivers within the project scope ated with cost estimates and risk. include the introduction of new tech­ Estimation accuracy Risk. An uncertain event or condition that could affect a project objective or A capital cost estimate is expressed nology into the process and the level as a range of possible costs, rather of complexity in the physical system, business goal. Base estimate. Estimate including than a discrete "number." Effective as well as the execution strategy. allowances, but excluding escalation, cost estimators work to understand (and be honest about) the details and Bias currency risk, contingency and man­ factors that they do not know. Those Capital project management is a realm agement reserves. of intense cost pressures and biases. Allowances Resources included in preparing estimates must commu­ (base) estimates to cover the cost of nicate the project risks, the range of If high estimates scuttle project sanc­ tion, the estimator’s performance rat­ known, but undefined, requirements possible outcomes and, most impor­ ing and career development may be for an individual activity, work item, tantly, how those two go together. account or sub-account. Accuracy ranges are expressed as put at risk. In slow economic times, Contingency. An amount added to low and high percentages that form cancellation of a large project may allow for items, conditions or events a boundary around the expectation of mean the loss of the team's jobs. For how final actual costs will differ from decision makers, optimism bias often for which the state, occurrence or ef­ fect is uncertain, and that experience the estimate. For example, a range prevails. For many reasons, the desire shows will likely result, in aggregate, of +30%/-10% tells management and pressures to make a “go-ahead" that the final costs may be as much project decision can be immense. in additional costs (this excludes ma­ jor scope changes, catastrophic risk as 30% more or 10% less than the The more strategic the project, the events and conditions, escalation and estimate after taking into account all more these biases create pressure for of the identified risks. To be complete, lower cost estimates, resulting in dis­ currency risk). Management reserves. An amount range statements should inlcude the crepancies. On the other hand, over­ added to an estimate to allow for confidence in the range, (for instance, runs may be punished, and this drives conservative estimating practices by discretionary management purposes stating that 80% of the time, the proj­ ect will be within these bounds). It is those afflicted, particularly in small outside the defined scope of the proj­ project systems. ect, as otherwise estimated. May in­ also important to specify the refer­ These biases and their effect on ence point upon which the range is clude amounts that are within the de­ fined scope, but for which company based (it can be relative to the base estimating behavior are major sourc­ es of cost uncertainty. If the bias is leadership does not want to fund as estimate or to the funded amount, in­ cluding contingency). toward decreased base estimates, contingency, or that cannot be effec­ more contingency will be required, tively managed using contingency. Escalation. A provision in costs or Scope definition and risk and vice-versa if the bias is toward ■ prices that accounts for uncertain The level of scope definition is the increased base estimates. changes in technical, economic and greatest driver of cost uncertainty. fd/tons note Tt«s counts based on rtarmafcnloi/id nHo«' man. J. Inprow 'fa/ Contngency Estimates fc» Mae ReateSc market conditions over time. Inflation Estimate accuracy improves with the FYoject Budgets Own. Eng.. December 2014. pp 36-43.

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