a project is $1 million and is to be spent over a three-year period in approximately equal amounts per year. If we think personnel costs will comprise about 40 percent of that total, also spread equally over time, the wage/salary bill will be about $400,000. Split into three equal amounts, we have expenditures of $133,333 per year. If we estimate that wage/salary rates will increase by 6 percent per year, our expense for the second year rises to $141,333 (an increase of $8,000), and to $149,813 in the third year (an increase of $8,480). Failure to account for wage/salary inflation would result in an underestimate of project cost of about $16,500. This is an error of slightly more than 4 percent of the personnel cost and almost 2 percent of the total project budget.
Further improvements can be made by taking into account the fact that the prices of different inputs often change at very different rates. A quick examination of • the Bureau of Labor Statistics (BLS) wage and price indices, which cover a very large number of specific commodities and wage rates, will reveal that even in periods of stable prices, the prices of some things rise while others fall and still others do not change appreciably. Thus, the PM may wish to use different inflatory for each of several different classes of labor or types of commodities.
The proper level of breakdown in estimating the impact of price changes simply * depends on the organization's willingness to tolerate error. Assume that management is willing to accept a 5 percent difference between actual and estimated cost for each major cost category. In the example above, expected increases in wage/salary costs will use more than four-fifths of that allowance. That leaves less 'i than 1 percent (about $3,500) of allowable error, and the need to add one part-time T clerk to the project for a single year would more than use the remaining allowance
Other elements that need to be factored into the estimated project cost include an allowance for waste and spoilage. No sane builder would order "just enough" „ lumber to build a house. Also, personnel costs can be significantly increased by the .5 loss and subsequent replacement of project professionals. Not only must new peo-pie go through a learning period—which, as we have seen, will have a negative ef- ¡y-feet on production—but professional starting salaries often rise faster than the gen-eral rate of annual salary increases. Thus, it may well cost more to replace a person -who leaves the project with a newcomer who has approximately the same level of . experience.
We have already mentioned the inclination PMs have toward understating the «;; costs of a project in order to make it appear more profitable to senior managers, as well as the proclivity of lower-level project workers to overestimate costs in order to protect themselves. If the project is in its initial planning stage as a response to an RFP from an outside organization, over- and underestimation of cost can have a serious impact on the probability of winning the contract—or on the level of profit, if a win occurs. (A large proportion of such projects are bid on a "cost plus" basis.)
Serious ethical problems may arise during the process of estimating costs and submission of bids in response to a Request for Proposal (RFP). If the job is to be paid on a cost-plus basis, or even if it is a fixed-fee project, with fee increases allowed for special circumstances, some bidders may "low ball" a contract (submit underestimated costs). By doing this, they hope to win the bid, counting on the opportunity to increase costs or to plead special circumstances once the job is underway
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What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.