Project Management Institute

Taking step three with earned value

estimate and budget resources

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EARNED VALUE

Quentin W. Fleming and
   Joel M. Koppelman

Once the technical requirements of a new project have been properly defined (scoped), and the work planned and scheduled, the next logical step is to forecast how much the project will likely cost the owner. The project's required resources must be estimated, quantified, and then authorized in the form of detailed project budgets.

These three steps are required in order to employ the earned value concept on a new project. It is no different than the initial effort required to start any new project. They are simply basic project management fundamentals. But they are also critical to earned value, because once the project baseline has been put into place, actual performance against the baseline will need to be measured periodically for the duration of the project.

However, there is one feature that distinguishes earned value from other types of projects. That feature is the requirement for the finite planning and measurement of performance during the life of the project. Such detailed performance measurement takes place within management control cells, which are referred to in earned value projects as “cost accounts.”

Routinely on a monthly basis, but sometimes quarterly or even weekly the project manager will make an assessment of how well the project is doing against its planned value baseline. The performance to date will be precisely measured employing earned value metrics, normally expressed as performance indices, and the results used to predict the final cost requirements for the project. These assessments are used to determine whether or not corrective actions need to be taken in order to stay within the owner's funding authorization.

The process of taking these three steps to form a planned/earned value project baseline are illustrated in Figure 1. The end result of taking these steps will be the formation of “cost accounts,” measurable performance cells for the project. The significance of the cost account needs to be understood in order to properly grasp how the earned value concept operates.

Earned Value “Cost Accounts”: i.e., Management Control Cells

Now we need to cover what is perhaps the single most important issue that distinguishes any project employing the earned value concept from those projects that do not.

Earned value is a technique for accurately measuring the project's planned value of the work against an earned value performance standard. This relationship tells the project manager precisely how much of the planned (scheduled) work has been accomplished, as of a point in time. It tells whether the project is ahead of, right on, or behind the work it set out to do. It provides the project manager with a planned schedule performance factor.

Additionally and perhaps of greater importance, earned value is a technique for accurately measuring the costs being spent against this same earned value performance standard. This relationship will determine the cost efficiency factor being achieved on the project. What work was achieved by the project for what was actually spent. The cost efficiency factor is particularly critical because poor cost performance is non-recoverable to the project. Historically over the past quarter of a century, whenever projects spend more than they achieve, they do not get well with time. Historically, overruns get worse with the passage of time.

Earned value requires that a detailed bottom-up baseline plan be put in place. The baseline in earned value is formed with the creation of uniform, self-contained, measurable cost accounts. The technique can be employed on projects as small as a few hundred thousand dollars, to projects as large as billions of dollars. The concept is scalable, as long as certain fundamental principles are followed and the baseline is formed with use of cost accounts.

Earned value came to us from the industrial engineers in the factory where they used the concept when they employed planned standards, earned standards, and then brought in the actual labor hours. Any project manager can emulate this same technique by simply creating standards against which project performance may be measured. The measurable standards need to be contained in homogeneous cells, or cost accounts. However, each cost account must precisely contain a defined scope, schedule, and budget to be viable.

A little background on the term “cost account”: in 1967 when the Department of Defense (DOD) first issued their Cost/Schedule Control Systems Criteria (C/SCSC) they chose to call these measurement units “Cost Accounts.” The cost account was defined as the intersection point of the lowest WBS element with a single functional element. More recently, with the broad acceptance of concurrent engineering (product development teams), the use of a single functional element has been expanded to include all functions working on a single WBS element. The DOD has consistently used the term cost account.

In 1992, the Department of Energy (DOE) officially changed their term to “Control Accounts,” which is perhaps a more descriptive and generic term. The DOE‘s definition and meaning are identical to the cost account. The cost account or control account is the measurable unit that contains a precise scope of work (the tasks), schedule, budget, and relates the accounts to the functional people who will perform the tasks. It is also the place where the planned value, earned value, and actual costs are measured.

Shown in Figure 2 is a diagram of cost accounts. These cells constitute the natural intersection point of the lowest WBS element with the functional organizations who will perform the tasks. In this illustration, our project manager Noah has defined the effort of his project with the use of a WBS. At the intersection of the lowest WBS element, he then relates the defined tasks over to the respective functions of the lucky contractor chosen to construct the Ark and its related equipment.

Figure 1. Three Steps to Form a Project Baseline

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One important point on the use of cost accounts: they require four elements in order to be viable for earned value measurement. They must contain at a minimum: (1) a scope of work, typically expressed in project tasks; (2) a time-frame to complete these tasks, i.e., the schedule; (3) finite resources, i.e., approved budgets, expressed in any measurable form, dollars, hours, etc.; and (4) a designated responsible cost account manager (CAM). The responsible cost account manager will likely be dually accountable for performance to both Noah as project manager and to the functional manager in the organization who placed that person in the roll of cost account manager.

All performance measurement in earned value projects occurrs within the confines of the cost accounts. The cost account is the building block of performance measurement and the sum of the blocks (cost accounts) will add up to the total project. Scheduling activities for the project will set the planned value for each cost account and then determine the earned value performance against the plan, using the same metrics that initially set the plan.

On smaller projects of only a few hundred thousand dollars in value, there will only be a few cost accounts created. On larger projects of millions or even billions of dollars there will obviously be more cost accounts out of necessity In each case, the project manager and the individual cost account managers will determine the appropriate number, length and size of the cost accounts for a given project.

There are no set dollar values recommended for the size of cost accounts. The rule of thumb is what is manageable for the cost account manager, for a given scope of work. What is manageable will vary by type of work. If the effort is for a research and development effort, versus a production run, versus a construction job, what is manageable will likely change. The amount of materials included, the degree of personal supervision required, the complexity of the effort, will all play in determining what constitutes a manageable cost account.

Integrating the Project's Cost and Schedule and Technical Scope

One somewhat unique aspect of employing earned value is the fact that the technique requires that there be an integration of all vital facets of the project: the scope definition, work authorization, planning, scheduling, estimating, budgeting, cost accumulation, and so forth. Rarely is full integration achieved on most projects.

When the C/SCS Criteria were issued in 1967, they precisely stipulated this requirement in one of their 35 criteria:

1. c. Provide for the integration of the contractor's planning, scheduling, budgeting, work authorization, and cost accumulation systems with each other, the contract work breakdown structure, and the organizational structure.1

This requirement for project integration is satisfied with use of the cost accounts, which are placed at the lowest levels of the WBS. Within each cost account, the project tasks are precisely defined and then related to the functional organization that will perform the work on a matrixed assignment to the project. The actual integration takes place with use of the cost accounts, which by definition contain the discrete scope, schedule, budget and a designated CAM. The cost accounts can be summarized either vertically up to the top levels of the WBS, or horizontally to the top levels of the organization, as depicted in Figure 2.

Estimates Versus Budgets…and Management Reserves

An opinion: All project managers need some type of “just-in-case” reserves to properly carry out their demanding roles. These funds are sometimes called contingency reserves, other times management reserves, whatever. These are simply set-aside funds over and above the budgeted values that await the misfortunes that will come to the project…they always have and they likely always will. In the schedules, such reserves will take the form of float, in addition to the cost cushions.

One important issue to the project: Who should control these cash or time reserves? Our position: Assuming they can be found, the project manager should always control such funds and float values. Why? For this answer we go to an established authority on the subject of project management, who expressed it nicely.

It is a natural tendency on the part of every person to provide a certain amount of cushion or reserve in his or her time and cost estimates…If approved, then each person will tend to expend all the time and cost available…as Parkinson has said:

The work at hand expands to fill the time available.

Expenditures will rise to meet the budget. 2

If a project manager allows more time in the schedule than is needed to perform the tasks, somehow people will have a tendency to take all the time that has been authorized, and the excess time will likely cost money Also, if more funds are approved than are needed to accomplish the work, somehow these funds will get spent.

What most of the more astute project managers have learned to do is to authorize only that which is needed to actually accomplish the job. Any differences are kept by the project manager for the potential mishaps which will happen, but just cannot be predicted in advance.

Conclusion

In a project that employs the earned value cost management concept, the project's measurable performance plans are formed with the creation of detailed cost accounts, placed at the lowest element of the project's WBS. The WBS serves as an integrator of all activities for the project, and allows the defined work in the detailed cost accounts to be assigned to the functional organizations performing the work.

Figure 2. Form Cost Accounts

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The formation of cost accounts is the last of three steps necessary steps to form an earned value performance measurement plan: define scope, schedule work, add the resources in the form of budgets. The result of this effort is to create a detailed baseline against which project performance can be measured throughout the life of the project.

This article is fourth in a series on the use of the earned value cost technique in the project management process. The authors’ position is that earned value can be a valuable tool for any project manager, providing it is used in its generic, simple form. The method can provide the project manager and the owner with an “early warning” signal of impending cost problems…in time for the project management to react. The previous articles in this series were: “The ‘Earned Value’ Concept: Back to the Basics” (January 1994); “The ‘Earned Value’ Concept: Taking Step One—Scope the Project” (May 1994); and “The ‘Earned Value’ Concept: Taking Step Two-Plan and Schedule the Project” (September 1994).

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. Russell D. Archibald, 1992, Managing High Technology Programs and Projects (New York: John Wiley & Sons), who is quoting from C.N. Parkinson, 1957, Parkinson's Law (Boston: Houghton Mifflin). img

 

Quentin W. Fleming is a senior staff consultant to Primavera Systems, Inc., with over three decades of industrial experience. His latest book is Cost/Schedule Control Systems Criteria—The Management Guide to C/SCSC.

JoeI M. Koppelman is president, co-founder, and co-owner of Primavera Systems, Inc. He is a registered professional engineer and has spent more than a decade in the managing of capital projects in the transportation industry.

This material has been reproduced with the permission of the copyright owner. Unauthorized reproduction of this material is strictly prohibited. For permission to reproduce this material, please contact PMI.

PM Network ● January 1995

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