The estimating relationship method enables project personnel to evaluate a project, and based on that evaluation, to apply an equation to determine an appropriate contingency or risk funds budget. When using this method, the contingency funds represent the amount of funding (above that deter- mined by cost analysis alone) required for work associated with unantici- pated risks. The contingency funds requirement computed is usually expressed as a percentage of the baseline cost estimate. The technique is called an estimating relationship method because it uses some of the same techniques associated with cost estimating relationships (CERs) used in parametric cost estimating.
Technique Description
The CER method is based on the observation that costs of systems seem to correlate with design or performance variables. The independent variables, often called explanatory variables, are analyzed using regression analysis to describe the underlying mechanism relating such variables to cost. This approach to cost estimating is widely accepted and easy to apply, even for complex functions.
This ease of application makes it natural to apply the same techniques to estimate costs that result from risks. The approach attempts to discover which project characteristics can be refined into discrete variables, which can then be correlated with the historically demonstrated need for contingency or risk funds. Regression analysis using actual contingency fund figures from past projects (as expressed as a percentage of total costs) is performed to develop an equation with which to estimate contingency fund requirements for a new project not in a database.
The application of this technique is described below. In an example describing this application, project personnel evaluate four project and subcontractor characteristics known to affect the level of uncertainty.
Each characteristic is assigned a value based on a scale provided for that characteristic. For this example, the four characteristics and their values are: engineering complexity (0 to 5); organizational proficiency and experience (0 to 3 ) ; degree of system definition (0 to 3 ) ; and multiple users (0 or 1). The sum of these numerics is entered as the value X in an estimating equation such as the f ~ l l o w i n g : ~
This formula determines the percentage contingency fund requirement, y. The model shown in this example is usable only for X values between 2 and 12. Lower values indicate essentially no need for contingency funds.
When Applicable
This method of estimating the additional funding needed to cover
anticipated risks has limited application. It can be used only if the research has already been done to establish a valid historical relationship between the key project characteristics or contract characteristics of similar projects and contingency fund requirements. The method is most applicable in circumstances in which good historical project description and contingency fund requirements are available for several similar projects. If the required risk funding estimating relationship is available, this method has the advantage of being both quick and easy to apply.
Inputs and Outputs
The inputs for an estimating relationship model, such as the equation under the heading "Technique Description," consist of judgment values characterizing the four project or contract factors described in the example.
Regarding outputs, the estimating relationship method provides a percentage that is applied to the estimated baseline cost to determine the amount of total or contract contingency funds required. This percentage value is computed using an equation similar to that used in the example, with the X value being the sum of the four factor values project personnel have determined.
Major Steps in Applying the Technique
When an appropriate contingency estimating equation is not available, the first step in using this method is by far the most challenging: to develop an
'
The figures in this equation were derived in the U.S. Department of Defense environ- ment by the Defense Systems Management College. As such, they may or may not be appropriate within your organization. They are based on the collective experience of the organization and the implications of those specific characteristics within their project environments.164 Chapter 18
equation relating project characteristics to contingency fund requirements.
The most difficult part of this step is finding valid historical characteristics and contingency fund data for enough similar projects to carry out regres- sion analysis. Data from a minimum of 10 past projects should be used to develop an estimating relationship equation.
The second part of this step is to determine the project or contract characteristics that drive contingency fund requirements and for which historical data have been collected. After collecting the historical data, using regression analysis to identify these characteristics is relatively simple.
The summing of judgment values for each of the four project character- istics, as done in the previous example, is only one way to develop one or more independent variables for an estimating relationship for contingency fund requirements. Geometric mean or weighted average techniques could also be used. Multiple regression analysis techniques frequently are used for parametric cost estimating.
The final step is to use the prediction equation derived through extensive analysis of past projects (coupled with the current project characteristic information) to compute a percentage for the contingency funds needed to cover anticipated additional costs associated with risk. It may be useful to vary the project description characteristic data somewhat and recompute the estimating equation to assess the impact of such changes on the computed contingency requirements. This sensitivity analysis is usually prudent because of the uncertainty associated with the predicted project or contract characteristics.
Use of Results
To cover funds needed for risk, a percentage of the estimated contract or project cost is added to the basic cost estimate. For example, if the contract cost estimate was $100 million and the prediction equation provided a result of 20 percent, $20 million would be added for risk, making the total estimated contract cost $120 million.
Resource Requirements
After a suitable contingency fund requirement
re diction
equation is available, only a few hours are required to apply this method. Most of the effort required involves interviewing project ~ e r s o n n e l to obtain their insights into the contract or project characteristic values to be used. If a prediction equation needs to be developed, it would require 1 to 3 months of a skilled analyst's time, depending on the difficulty in acquiring the needed data. However, if the required data are not available, it becomes impossible to produce a satisfactory prediction equation.Estimating Relationships 165
Reliability
This method provides results that significantly increase cost estimates8 in order to allow for risk. Because the additional funds are based primarily on judgment values, they are subject to question. It would always be prudent for the project manager to have upper management review and approve the method (including the prediction equation to be used) before using it as the basis for a viable request for addition risk funding. The method can be used only where adequate historical data are available to develop a sound contingency fund requirement prediction equation.
Selection Criteria
As with each chapter on techniques, estimating relationships are assessed using selection criteria relating to resource requirements, applications, and outputs for the technique. To compare estimating relationships with other techniques, review Table 6.
Resource Requirements
a The cost of the estimating relationship technique depends largely o n the availability of a parametric cost model specifically designed to estimate contingency reserve or risk funds as a function of one or more project parameters. If such a model is not available, 1 to 3 resource- months may be required to develop it. If the required historical data are not available, developing the required cost model may be impossible.
O n the other hand, if a satisfactory model is available, it generally takes only a few days at most to apply it.
w Proper facilities and equipment relate primarily to the databases with the appropriate information and the tools themselves. Otherwise, very little equipment is required. The model equations are usually so simple that a calculator is adequate to compute required contingency reserve fund requirements.
The time needed to implement the technique can range from a matter of days to as long as 3 months depending on the maturity of the
organization in terms of the technique. If the technique has been developed and exercised regularly, then only a few days will be required. Otherwise, a 1-3-month window is required to develop the appropriate information.
w Estimating relationships have high ease of use because after they are built, they require only the appropriate calculations to be developed.
This is based on extrapolating historical data that may include costs for risks that have already been experienced.
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Ease of use after the models are constructed becomes a function of ease in data gathering.
w The project manager's time commitment is extremely limited, but there are some responsibilities for the project manager. The project manager must support the technique's use so that key project personnel will provide the cost analyst with time judgments or information needed as inputs for the model.
Applications
w This technique does not support project status reporting well. It is instead far more effective as a tool at project inception rather than at project midpoints.
w The only major planning decision that the technique supports is determining the extent of contingency reserve or risk funds to be included in the initial budget request or baseline budget.
w The contract strategy selection may hinge in small part on the level of risk funding required for the project. Otherwise, there is no relationship between the technique and this application.
w This technique does not support milestone preparation and design guidance.
w Source selection may be a critical input to the technique, but the estimating relationship outputs do not support it.
Budget submittal is the primary application for this technique. By computing the level of contingency reserve or risk funds required, the project manager can develop a budget that incorporates and reflects risk issues and allows for the vagaries of real-world project
management.
Outputs
w The accuracy of the technique is considered low, primarily because the historical databases on which such models are based are small. The accuracy also comes into question because accurately defining what funds were spent to address risk on past projects is often difficult.
This method provides a level of detail that is unacceptable to the detail- oriented analyst. It provides little or no information with respect to which parts of the project are at greater risk and, therefore, more likely to require additional funding.
Because so few models of this type are available and even their uses are subject to question, the overall utility of this method must be
considered low.
Estimating Relationships I 67
Summary
Many project managers do not understand the estimating relationship method well. Some survey respondents indicated that they had used this technique when they had really used parametric cost estimating methods for some or all project cost estimates. Such analysis is more accurately described as all or part of a life-cycle cost analysis. The use of parametrics estimating methods defines the estimating relationship method to estimate risk or contingency reserve fund requirements. Currently, few parametric cost models are available with which to do this.
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