Approaches to Cost Estimation
Cost estimating is one of the most important steps in project management. A cost estimate establishes the base line of the project cost at different stages of development of the project. A cost estimate at a given stage of project development represents a prediction provided by the cost engineer or estimator on the basis of available data. According to the American Association of Cost Engineers, cost engineering is defined as that area of engineering practice where engineering judgment and experience are utilized in the application of scientific principles and techniques to the problem of cost estimation, cost control and profitability.
Virtually all cost estimation is performed according to one or some combination of the following basic approaches:
Production function. In microeconomics, the relationship between the output of a process and the necessary resources is referred to as the production function. In construction, the production function may be expressed by the relationship between the volume of construction and a factor of production such as labor or capital. A production function relates the amount or volume of output to the various inputs of labor, material and equipment. For example, the amount of output Q may be derived as a function of various input factors x1, x2, …, xn by means of mathematical and/or statistical methods. Thus, for a specified level of output, we may attempt to find a set of values for the input factors so as to minimize the production cost. The relationship between the size of a building project (expressed in square feet) to the input labor (expressed in labor hours per square foot) is an example of a production function for construction. Several such production functions are shown in Figure 3-3 of Chapter 3.
Empirical cost inference. Empirical estimation of cost functions requires statistical techniques which relate the cost of constructing or operating a facility to a few important characteristics or attributes of the system. The role of statistical inference is to estimate the best parameter values or constants in an assumed cost function. Usually, this is accomplished by means of regression analysis techniques.
Unit costs for bill of quantities. A unit cost is assigned to each of the facility components or tasks as represented by the bill of quantities. The total cost is the summation of the products of the quantities multiplied by the corresponding unit costs. The unit cost method is straightforward in principle but quite laborious in application. The initial step is to break down or disaggregate a process into a number of tasks. Collectively, these tasks must be completed for the construction of a facility. Once these tasks are defined and quantities representing these tasks are assessed, a unit cost is assigned to each and then the total cost is determined by summing the costs incurred in each task. The level of detail in decomposing into tasks will vary considerably from one estimate to another.
Allocation of joint costs. Allocations of cost from existing accounts may be used to develop a cost function of an operation. The basic idea in this method is that each expenditure item can be assigned to particular characteristics of the operation. Ideally, the allocation of joint costs should be causally related to the category of basic costs in an allocation process. In many instances, however, a causal relationship between the allocation factor and the cost item cannot be identified or may not exist. For example, in construction projects, the accounts for basic costs may be classified according to (1) labor, (2) material, (3) construction equipment, (4) construction supervision, and (5) general office overhead. These basic costs may then be allocated proportionally to various tasks which are subdivisions of a project.