Quality Based Costing

Accurately quantify risk and systematically reduce exposure

Applying risk management to an ongoing programme to “rescue it” is quite a common occurrence. But the problem is that the programme has already gone wrong and this is often due to the fact that the estimating assumptions made when the project was in the scoping/proposal stage were fundamentally incorrect. This often leads to insufficient budgets, short-cuts and damaged business relationships that ultimately undermine the project leading to delays, scoping reductions and even total project failure.

So what’s wrong with traditional estimating techniques?
Traditional estimating approaches take good quality estimates (eg capital assets) and poor quality estimates (eg resource estimates for activities never attempted before) and simply add them together to produce an add-up cost which conceals the uncertainties. Further if these uncertainties are now lost in the add-up cost there is no way of re-analysing and therefore no way of managing the cost-risk by directly addressing the uncertainty risks.

What can be done to improve this?
Quality Based Costing (QBC) is a proven way of accurately estimating the cost-risk (ie budget, timescales and/or benefits) in any size of programme. It essentially works by acknowledging the inevitable quality variations in the estimates and underpins all estimates with their underlying assumptions.

How does Quality Based Costing work?
QBC uses the concept of first identifying the strategic cost Bricks in the project. The term Brick is simply used to avoid confusion with Work Packages, activities, tasks etc and the size of a Brick can vary considerably depending on the stage of project. The first step is to build the Brick Wall and when this is complete, the total cost structure of the project is represented (with no estimates, at this stage).

Brick Owners are allocated for each Brick based on the ability to estimate the specific Brick as accurately as possible. Brick Owners are then interviewed to break-down the Brick estimates into its components.

This is done by asking structured questions that break the Brick down into:
A =                          Absolute minimum
A + B =                   Best guess/realistic estimate
A + B + C =            Contingency added
A + B + C + D =     Disaster scenario

The assumptions that underpin the estimates are also captured using the ABCD Assumption Analysis process. The key factor here is that the ratings of the assumptions must be consistent with the estimate breakdown and the interview often results in challenges to the estimates and/or assumptions to make them consistent.

 

risky assumption

 

Each Brick then has two probability distributions built around the estimates – one for the “Contingency Scenario” and one for the “Disaster Scenario”.

 

ABCD graph

 

 Monte Carlo simulations are then run to statistically add the Brick estimates together.

The resulting probability distributions can be interpreted to make crucial budgeting or pricing decisions i.e.

  • There is a “zero” probability of the project costing less than the “Base Cost”
  • The 50% confidence cost means that there is an 50-50 chance of the project costing less or more than this value
  • The 90% confidence cost is normally considered to be the “ideal” cost to budget (if this is considered affordable)
  • To be meaningful, the project must be funded somewhere between the 50% and 90% costs
  • The Add-up cost is simply the value that would have been reached through “traditional” estimating
  • The Add-up cost could appear anywhere on the graph but normally appears below the 50% point – is it therefore not surprising that traditional estimating is so far out?

probability

Using QBC for competitive advantage
QBC is often used at the proposal stage of a project to provide the best possible information for competitive pricing. In non-competitive environments it provides a scientific way of guaranteeing fair budgets and profit. In competitive situations, it allows suppliers to understand the level of risk that they are taking-on if they choose to cut their price for strategic reasons. However, it also allows for innovative pricing scenarios which can produce the most aggressive (fixed) price but with reduced risk to the supplier i.e.

  1. Identify all Bricks where a client dependency is driving the uncertainty
  2. Take out the C and D components for these Bricks and re-run the simulation
  3. The difference between the profiles allows a fixed-price and a “contingency” to be negotiated
  4. Capture and quantify the value of these assumptions in the contract
  5. Re-run the simulation periodically (e.g. at each major milestone)

project cost

 

Assure Web-based Toolset
Assure is a powerful web-based tool that allows the ABCD data captured to be easily managed and reports (eg Assumption/Risk Registers and risk profile “Bubble Diagrams”) to be produced. The information is viewable via any browser so that communication is made more effective across your intranet or secure internet. The Monte Carlo functionality required for the QBC process is integral to Assure and links directly from the Bricks to the assumptions providing a fully functional ABCD based Enterprise Risk Management system.

Would you like to know more about risk management?

We are confident that just an initial call will provide enough information to create a new outlook regarding the impact of risk management on your business.[/action]