Taking step four with earned value

EARNED VALUE Quentin W. Fleming and    Joel M. Koppelman

Some project managers refer to it as their “stake in the ground.” Others describe it as a “point of reference.” Whatever it is called, all projects need to establish some type of a baseline against which their efforts may be monitored during the period of project performance.

This is true for all projects, but it is particularly critical for any project that employs the earned value cost management concept. Once under way, projects using earned value will need to know precisely how much work they have accomplished: 15, 16, or 17 percent, in order to be able to forecast with some degree of confidence what the total bill might cost the owner to accomplish 100 percent of the project. With a precise measurement of the physical work accomplished, called the “earned value,” the project manager may then compare that amount with the “actual costs” spent to accomplish the earned value, to determine what they got for what they spent. The critical relationship of the earned value to the actual costs determines the project's cost efficiency factor, referred to as the cost performance index, or CPI. Project managers, senior executives, the owners, should all be sensitive to what they are getting for what they are spending to their CPI. Reason: they may use such information to intelligently forecast how much the total project will likely cost them to complete it.

A project baseline is needed in order to determine precisely how much of the planned work has been accomplished, as of any point in time, to compare with the actual costs to accomplish that work. A project baseline is required in order to employ the earned value concept.

Establishing the Baseline

The necessity of forming a project baseline is fundamental to the project management process … period. What is slightly unique about a project baseline as used for earned value applications is that such baselines must be capable of being measured with exact precision throughout the full life cycle of project performance.

When the 35 Cost/Schedule Control Systems Criteria (C/SCSC) were first issued in 1967 one of them specifically dealt with the issue of a performance measurement baseline. This criterion required that all projects:

2. c. Establish and maintain a time-phased budget baseline at the cost account level against which contract performance can be measured. Initial budgets established for this purpose will be based on the negotiated target cost. Any other amount used for performance measurement purposes must be formally recognized by both the contractor and the Government.¹

To expand the earned value concept beyond simply a government-imposed requirement, and that is our intent with these articles, we must substitute the word “owner” for “government” as used in the last line of the above quotation. The government or owner of the project must approve all changes to the performance measurement baseline.

The term cost account, a type of management control point, is the central core for earned value performance measurement. Within each cost account must be contained: (1) a specific scope of work, (2) a time frame, and (3) a budget. Each cost account has the capacity of discerning its planned value, earned value, and actual costs. The project's total performance baseline is therefore the summation of its individual cost accounts.

To illustrate this thought please refer to Figure 1, which subdivides a total project into its respective performance measurement baseline elements. At the top of the figure is displayed the project target price. After conscription of the profit/fee by the chief financial officer, the project manager is left with the project budget base, referred to in some quarters as the total allocated budget.

The project budget base is the value that the project manager has to allocate to all planned costs for the project. It must include both direct and indirect project costs, even though the indirect costs will likely be beyond the immediate control of the project manager. Nevertheless, the project budget base must provide for all project costs, except forecasted profits/fee.

One critical issue for any project manager is the necessary subdivision of the project budget base into two distinct parts: (1) the negotiated target costs, and the (2) authorized but not yet negotiated changes to project scope. In order to keep the project baseline consistent with the realities of a dynamic and ever-changing environment, the performance baseline must include both negotiated scope and that effort which is recognized as a legitimate change but the exact value of which has not been agreed to between the owner and the project manager. Figuring out precisely what to do with authorized but unnegotiated work is always a challenge for the project manager. However, one rule is absolute: all authorized changes must be included in any project baseline in order to maintain the integrity of such baselines.

The next item that must be addressed is that of the project manager's contingency or management reserve (MR). MR is something that is needed by all projects, should be controlled by the project manager, but few people will talk about it, and certainly not in public places. MR must be subtracted from the project budget base in order to reach the point of earned value performance measurement. This term is aptly called the performance measurement baseline, or simply the PMB. This item has been defined as:

the time phased budget plan against which contract performance is measured. It is formed by the budgets assigned to scheduled cost accounts and the applicable indirect budgets. For future effort, not planned to the cost account level, the performance measurement baseline also includes budgets assigned to higher level contract work breakdown structure elements and undistributed budgets. It equals the total allocated budget, less management reserve.²

The PMB is displayed at the center of Figure 1, and is central to the earned value cost management process. Within the PMB will be housed two categories of budgets: the allocated budgets, taking the form of cost accounts, and the undistributed budgets.

Undistributed budgets are a special planning category of funds that may cover both far-term unplanned work and any additional scope that has been authorized by the owner but not yet negotiated between the parties. Obviously the unnegotiated effort is subject to a change in value, but nevertheless must be accounted for in the project baseline.

While undistributed budgets will reside at a higher summary planning level, such budgets need to be allocated to a specific element of the project's work breakdown structure (WBS). Until undistributed budgets move into definitive planning, they may or may not be allocated to specific organizations for performance. However, all budgets within the PMB must be allocated to a specific WBS element and properly time-phased in order to assure the integrity of the performance measurement baseline.

The cost account budgets will be subdivided into two distinct categories: detailed work packages for the near-term effort, and planning packages for the distant work. There are no absolute rules for making the distinction between what constitutes a work package, versus a planning package, or undistributed budgets. These somewhat general categories will vary by project. However, employing the “rolling wave” planning concept, projects with a duration of up to three years may well plan all of their cost accounts down to the work package level. Other projects exceeding three years in duration may define their near-term effort in definitive work packages, but leave their out-year tasks in higher-level planning packages until they approach the period of performance. Projects with less than a five-year duration may have no use for undistributed budgets, except to temporarily house authorized but not yet negotiated changes in scope.

Once the performance measurement baseline has been set, based on individual cost account planning, the next appropriate action is to time-phase the baseline to form a total project performance curve, as is displayed in Figure 2. In this display we have illustrated a project baseline of sufficient duration to warrant the use of cost account work packages for the near-term, planning package for the later periods, and undistributed budgets for the far-term effort. As mentioned earlier, shorter-term projects will often only utilize work packages because of their limited duration, as may be appropriate for a particular project.

This particular display can be used by management to not only monitor cost and the dollarized schedule performance but also to relate such achievements with the completion of major project milestones. Major project milestones are displayed across the top of Figure 2 and provide an effective way to relate both cost and schedule performance for the project.

Maintaining the Baseline: Managing Changes in Scope

A wise person is alleged to have once said: “there are three certainties in life … taxes, death, and changes in project scope.” That wise individual must have worked on projects similar to ones on which we have all worked.

It is always frustrating to work hard to set a project baseline, to have all parties agree on the baseline, then watch as the changes begin. Likely it would not be possible to eliminate changes altogether, even if we could. Changes to project scope often result in improvements in the final product. But if we could not eliminate changes altogether, at least we should strive to control the changes so that they represent what we deliberately intend to do and not simply what we were unable to avoid.

Setting a firm baseline in place, based on an agreed-to scope of work that all parties understand, is likely a key initial action required by the project team. A closely related initial task is for the project team to put into place some type of control procedure that will allow them to either approve or reject changes in work based on a deliberate determination by the team. Changes in scope should not accidentally happen because someone failed to prevent them. Rather, a change in scope should only happen when specifically approved by those authorized to make the change, acting on behalf of the project manager.

In order to manage changes, the project needs to keep track of all opportunities they may experience to change direction, deliberately or inadvertently. Controlling a baseline requires information, and an information retrieval system. Each action that alters or potentially alters the approved baseline needs to be carefully logged so that the project management team may consciously decide whether or not the change will be approved or rejected.

Shown in Figure 3 is a simple baseline change control log. The first line item on such a log would be the initial approved project baseline value. The next lines are reserved for the change actions, to be listed in chronological order as they happen. Each change or potential change as it happens must be listed as a line item on the log.

As each potential change evolves, the information will need to be systematically added to the log as it becomes available. For example, the rough order of magnitude (ROM) dollars need to be estimated and listed, the authorized not-to-exceed (NTE) dollars need to be shown, leading ultimately to a negotiated amount and resulting change order (CO) issued.

Effective project management requires that records and logs be kept, and that some type of a simple information retrieval system be put in place.

Conclusion

Establishing a detailed, bottom-up project management plan is needed in order to employ the earned value cost management concept. Such plans need to be built upon detailed and individually measurable cost accounts, the summation of which will form a time-phased performance measurement baseline.

Managing project scope changes as they happen is essential to maintaining the approved project baseline, and is also necessary to employ the earned value concept. ■

Notes

1. United States Department of Defense Instruction (DODI) 5000.2, February 23, 1991, Defense Acquisition Management Policies & Procedures, Part 11, Section B, Attachment 1.

2. United States Department of Defense Instruction (DODI) 5000.2, February 23, 1991, Defense Acquisition Management Policies & Procedures, Part 11, Section B, Attachment 2.

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