Project planning - Cost estimation techniques

Learning Outcomes

After reading this article, you will understand and be able to compare key cost estimation techniques used in project planning, including analogous and parametric methods. You will know when to use each method, recognize their strengths and weaknesses, interpret related exam questions, and avoid common pitfalls. You will also be able to apply basic formulas for parametric and three-point estimation, and confidently address estimation scenarios on the PMP exam.

PMP Syllabus

For PMP, you are required to understand cost estimation approaches and their application during project planning. Revise the following areas before focusing on this article:

• Identify and explain major cost estimation techniques: analogous, parametric, and three-point.
• Compare the strengths, weaknesses, and appropriate use cases of each technique.
• Know how to obtain and apply historical data for estimation.
• Understand the use of parametric formulas and unit rates.
• Apply three-point estimation (simple average and weighted average).
• Assess the impact of uncertainty and risk on cost estimation.
• Recognize when to fine-tune estimates based on available project information.
• Select, justify, and defend the cost estimation method chosen in given project scenarios.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which estimation technique relies on the budget or duration of a previous similar project, scaled for size?
   1. Analogous Estimating
   2. Parametric Estimating
   3. Three-Point Estimating
   4. Bottom-Up Estimating
2. If you have a cost per square meter to build office space and apply it to new buildings, which estimation method are you using?
   1. Analogous
   2. Parametric
   3. Top-Down
   4. Rolling Wave
3. What is the primary advantage of three-point (PERT) estimation over single-point estimates?
   1. Simpler to calculate
   2. Gives a range to account for uncertainty
   3. Ignores historical data
   4. Costs more to implement
4. In what project situation is analogous estimating LEAST appropriate?
   1. You have access to detailed WBS and historical data.
   2. The project is in an early concept stage.
   3. A similar project was completed last year.
   4. Little detailed information is available.

Introduction

Thorough and reliable cost estimation is essential to successful project planning. Estimation techniques help project managers establish credible budgets, secure funding, and set realistic expectations for all stakeholders. The PMP exam frequently assesses your ability to select the right estimation method for the situation, apply basic formulas, and justify your approach.

Cost estimation is performed iteratively—estimates become more precise as more project information becomes available. Early in the project, rough but rapid techniques are used; closer to execution, more detailed and refined methods are selected.

In the PMP context, you need to be able to differentiate between major estimation approaches—especially analogous, parametric, and three-point—and explain in which contexts each should be applied.

Overview of Project Cost Estimation

During planning, cost estimation is used to predict resources, time, and money needed to deliver all scope. Estimation is performed at multiple stages with increasing accuracy.

Key Term: Cost Estimation
The process of approximating the monetary resources required to complete project activities.

Cost estimates are affected by available data, project type, organizational standards, team skill, and the degree of uncertainty. The project manager should select the technique that provides sufficient reliability for the current stage of planning, balancing the need for speed and accuracy.

When Is Cost Estimation Performed?

• Initial high-level estimates are developed in the concept or initiation phase.
• More detailed estimates are refined during planning as the scope and WBS become clearer.
• Updates are made as changes occur or new information emerges.

Major Cost Estimation Techniques

Analogous Estimating

Key Term: Analogous Estimating
A top-down estimation technique that uses actual cost, duration, or resource data from a previous, similar project to estimate the cost for a current project.

Analogous estimating is typically used early in the project when there is limited detail. The estimator uses expert judgment and adjusts for known differences in project size, complexity, and location. It is fast but less precise.

Use when:

• Historical data from similar projects is available.
• Only high-level information exists.
• A quick estimate is needed for business case or initial budgeting.

Limitations:

• Less accurate than detailed methods.
• Relies heavily on expert judgment.
• Not suited for complex projects with unique characteristics.

Parametric Estimating

Key Term: Parametric Estimating
A technique that calculates cost or duration using a statistical relationship (e.g., cost per unit, time per task) based on historical data and project parameters.

Parametric estimates are more accurate when a strong correlation exists between an input (like square meters) and cost. Requires reliable historical data and formulas.

Examples:

• Cost per cubic yard of concrete
• Labor hours per drawing
• Dollars per feature

To use, multiply the known parameter by the rate:#

Use when:

• Detailed quantity or scope information is available.
• Processes or products are repetitive and standardized.

Advantages:

• Greater accuracy for similar, repeatable work.
• Easy to update as quantities change.

Drawbacks:

• Inaccurate if the parameter or unit rate is poorly defined.
• Assumes consistent conditions between past and current projects.

Three-Point Estimating

Key Term: Three-Point Estimating
A method that considers uncertainty by calculating the average of optimistic, most likely, and pessimistic estimates for cost or duration.

Three-point estimating provides a range and can be calculated as:

Simple Average (Triangular):

Weighted Average (PERT/Beta):

Use when:

• Uncertainty or risk may significantly affect costs.
• You seek to reduce bias in expert judgment.
• You want to provide a cost range rather than a single number.

Benefits:

• Accounts for risk by including best and worst cases.
• Encourages discussion of uncertainty and assumptions.

Choosing the Right Estimation Technique

• Analogous: Use when quick, high-level estimates are needed, or in concept/business case phase.
• Parametric: Use for projects with repetitive elements and available reliable data.
• Three-Point: Use when uncertainty or risk is significant; to improve the reliability of expert estimates.
• Bottom-Up (for reference): Used in later stages where detail exists; not covered in detail here.

Worked Example 1.1

You are tasked with estimating the base cost to refurbish a floor of office space. A similar project last year cost $250,000 for 1,000 m². Your current floor is 1,200 m² and design is nearly identical. What estimate technique should you use, and what is the estimated cost?

Answer:
Use analogous estimating. Adjust last year’s cost for the increase in area:

$$\text{Cost Estimate} = \$250,000 \times \frac{1,200}{1,000} = \$300,000$$

The estimated cost is $300,000.

Worked Example 1.2

A project requires 600 software licenses. From previous work, the cost per license is $140. What is the estimated total cost using a parametric approach?

Answer:
Parametric estimating:

$$\text{Total cost} = 600 \text{ licenses} \times \$140/\text{license} = \$84,000$$

The estimate is $84,000.

Worked Example 1.3

An uncertain activity could cost as little as $4,000 (optimistic), is most likely to cost $7,500, and could be as much as $12,000 (pessimistic). What is the three-point (PERT/beta) estimated cost?

Answer:
Use the weighted average formula:

$$\text{Estimated Cost} = \frac{4,000 + 4 \times 7,500 + 12,000}{6} = \frac{44,000}{6} \approx \$7,333$$

The three-point estimate is $7,333.

Exam Warning

Exam questions often present a scenario where you must choose the most appropriate estimating technique. Be aware that accuracy, speed, available data, and the level of detail required are common discriminators—choose accordingly.

Revision Tip

For rapid, early-stage estimates, always consider analogous; for repetitive or parametric work, use historical rates; for new or high-risk work, supplement with three-point estimating.

Summary

Accurate cost estimation is critical to planning, budgeting, and supporting informed project decision-making. Analogous estimating is fast and useful early, parametric estimating is effective for standardized work with reliable data, and three-point estimating addresses uncertainty by producing cost ranges. Always match the method to the available information, stage, and risk profile of your project.

Key Point Checklist

This article has covered the following key knowledge points:

• Analogous estimating uses similar past projects as a reference for new project cost estimates.
• Parametric estimating applies unit rates to quantities for more precise calculations.
• Three-point estimating (simple and weighted) provides cost ranges and incorporates uncertainty.
• Technique selection depends on project phase, data quality, detail available, and risk.
• Exam questions require identifying the rationale for technique choice, interpreting calculated estimates, and critiquing scenario-based answers.

Key Terms and Concepts

• Cost Estimation
• Analogous Estimating
• Parametric Estimating
• Three-Point Estimating