Project planning - Cost estimation techniques

Learning Outcomes

After reading this article, you will be able to identify and apply the major cost estimation techniques used in project planning, distinguish between estimating approaches, and understand how to tailor technique selection to project specifics. You will be prepared to select, explain, and justify appropriate estimation methods when answering PMP-style questions.

PMP Syllabus

For PMP, you are required to understand the various cost estimation techniques that underpin project budgeting and planning. Focus your revision on:

• The main purposes of estimating project costs during planning.
• Differences between and applications of key techniques: analogous, parametric, bottom-up, and three-point estimating.
• When to use each method based on project characteristics, information available, and required accuracy.
• The implications of estimate accuracy ranges and risk factors.
• How estimation methods integrate with schedule and resource planning.
• How to present, document, and defend cost estimates as a project manager.

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 cost estimation technique produces a rough, early estimate by referencing the costs of previous, similar projects?
   1. Three-point estimating
   2. Parametric estimating
   3. Bottom-up estimating
   4. Analogous estimating
2. What is the main advantage of bottom-up estimating?
   1. Lowest cost
   2. Fastest to produce
   3. Highest accuracy
   4. Least input required
3. When limited details are known at the start of a project, which estimation technique is typically most appropriate?
   1. Bottom-up
   2. Analogous
   3. Three-point
   4. Parametric
4. In three-point estimating, which formula provides a weighted average that puts greatest emphasis on the most likely value?
   1. (O + M + P)/3
   2. (O + 4M + P)/6
   3. (P + 4O + M)/6
   4. (O + P)/2

Introduction

Effective cost estimation is essential for project planning. Inaccurate estimates result in unrealistic budgets, missed deadlines, and project failures. This article reviews the major estimation techniques used during project planning and provides practical guidance on their selection and use for the PMP exam.

Key Term: Cost Estimation The process of forecasting the financial resources required to complete project activities, typically carried out during planning.

Why Estimation Matters

Cost estimating allows the project manager to propose a realistic budget, obtain stakeholder approval, and allocate resources appropriately. It supports schedule development, scope management, and risk planning.

All cost estimates are uncertain. The technique chosen depends on project specifics—such as available information, required precision, and time constraints.

Primary Cost Estimation Techniques

Analogous Estimating

Analogous estimating produces quick, early estimates by comparing the current project (or component) to previous, similar projects. This is a top-down approach.

Key Term: Analogous Estimating Producing a high-level or activity-level estimate by referencing actual costs of previous, similar projects or work packages, with adjustments for differences.

• Fastest method, used when little detail is available.
• Typical accuracy: low. Expect a wide range (e.g., –25% to +75%).
• Relies heavily on judgement and experience.
• Suitable for early project phases or rough order of magnitude (ROM) estimates.

Parametric Estimating

Parametric estimating uses mathematical models or cost-per-unit metrics to compute estimates based on project parameters.

Key Term: Parametric Estimating Using statistical relationships and historical data to predict project costs, e.g., $20 per meter installed or $500 per module.

• Requires reliable historical data and clear parameters (e.g., metres, hours, quantity).
• Faster than bottom-up once parameters are defined.
• Accuracy improves with strong data and documented relationships. Typical range: –10% to +25%.
• Efficient for repetitive, quantifiable work.

Bottom-up Estimating

Bottom-up estimating is a detailed approach where the cost of each project activity or work package is estimated individually, then these are summed to create the total estimate.

Key Term: Bottom-up Estimating Calculating detailed estimates for every activity/work package, aggregating them to produce the project cost estimate.

• Most accurate method, suitable when detailed scope and schedule information is available.
• Requires most effort and time.
• Typical accuracy: high, often –5% to +10%.
• Supports contingency and risk planning at a granular level.
• Demands substantial project and resource information.

Three-Point Estimating

Three-point estimating addresses uncertainty by incorporating optimistic (O), most likely (M), and pessimistic (P) scenarios to create a weighted estimate.

Key Term: Three-point Estimating Calculating cost by finding an average using three cost scenarios: optimistic, most likely, and pessimistic.

• Uses either the simple (triangular) average:
  (O + M + P)/3
• Or the weighted (Beta) average:
  (O + 4M + P)/6
• Reduces bias, accounts for uncertainty, and supports risk analysis.

Presenting Estimates: Accuracy and Ranges

Estimates are expressed with accuracy ranges to reflect uncertainty and confidence, for example:

• ROM estimate: –25% to +75% (very early stage)
• Budget estimate: –10% to +25%
• Definitive estimate: –5% to +10% (well-defined scope, using bottom-up)

Always document the basis of estimate, including assumptions, risk factors, and method used.

Exam Warning

Overconfidence in early estimates is a common pitfall. Always select an estimation method appropriate for available information and required accuracy. For PMP questions, remember that bottom-up is most accurate when detail allows.

Choosing the Right Technique

Selection depends on:

• Level of scope definition.
• Historical data and knowledge of similar work.
• Time and organisational resources available.
• Required accuracy.

If little detail exists, use analogous. If reliable parameters exist, use parametric. If detail is sufficient, choose bottom-up. For uncertainty, use three-point to supplement other methods.

Worked Example 1.1

A project manager is asked to estimate the cost of building a new 100-metre fence. The previous year, a 90-metre fence cost $18,000. The new project is similar in design and complexity. Alternatively, the cost per metre from past records is $200 per metre. What is the best estimate using (a) analogous, (b) parametric methods?

Answer: (a) Analogous: $18,000 × (100/90) ≈ $20,000.
(b) Parametric: 100 metres × $200/metre = $20,000.

Worked Example 1.2

An activity has the following three-point estimates for cost:
O = $1,000, M = $1,400, P = $2,000.
Calculate the estimate using both the simple (triangular) and Beta (weighted) formulas.

Answer:
Triangular: (1000 + 1400 + 2000) / 3 = $1,466.67
Beta/PERT: (1000 + 4×1400 + 2000) / 6 = ($1000 + $5600 + $2000)/6 = $8600/6 = $1,433.33

Revision Tip

Focus on understanding when to apply each estimation technique and always consider the required accuracy for your estimate. Small projects can often skip bottom-up due to limited detail, but high-risk or large-scope projects demand it.

Estimation Best Practices and Risk

• Document all assumptions and constraints.
• Use historical data, adjusting for current project differences.
• Always update estimates as more information emerges ("progressive elaboration").
• Include contingency for known risks.
• Review estimates for padding or hidden reserves.

Worked Example 1.3

During early project planning, a project manager is asked for a cost estimate but only has vague scope. She references a similar project that cost $350,000, despite differences in scale and complexity. What technique is she using and how should she express the result?

Answer:
She is using analogous estimating and should express the estimate as a rough order of magnitude (ROM), e.g., "\$350,000 ±25-75%".

Limitations and Coordination with Other Planning

No estimate is final—estimates must be reviewed as scope, schedule, and resource plans are updated. Estimation is tied to scheduling (duration estimates), resource allocation, and risk management.

Key Term: Basis of Estimate Information that explains how an estimate was developed, including assumptions, data sources, and uncertainties.

Summary

Thorough and accurate cost estimation is fundamental to reliable project planning. Select estimation techniques appropriate to the level of detail and information available. Always communicate accuracy ranges and update estimates as project plans develop. Be able to explain and justify your technique choice on the PMP exam.

Key Point Checklist

This article has covered the following key knowledge points:

• Accurate cost estimation is fundamental to project planning and control.
• Key estimation methods: analogous (top-down), parametric, bottom-up, and three-point.
• Technique selection should match available data and required accuracy.
• Present all estimates with stated accuracy ranges and basis of estimate.
• Bottom-up estimating offers the greatest accuracy but requires detailed inputs.
• Document assumptions and update estimates progressively as plans become clearer.
• Estimation integrates with scheduling, resourcing, and risk management.
• For PMP, be prepared to contrast and justify estimation techniques in scenario-based questions.

Key Terms and Concepts

• Cost Estimation
• Analogous Estimating
• Parametric Estimating
• Bottom-up Estimating
• Three-point Estimating
• Basis of Estimate