The value of earned value management
Earned value management (EVM) delivers three distinct values for those who fully understand how to use it: The first and primary benefit is the ability to predict project success or failure early enough in the project to implement successful corrective actions. The second value is permitting simplified progress reporting. This value is a bit controversial because people who do not fully understand earned value believe it complicates progress reporting. The third benefit, which has been lost to the earned value community entirely, is actually the reason earned value was created in the first place. This is the capability to forecast cash flow requirements. This paper will discuss each of these values in sufficient detail to understand how to obtain all three benefits with little or no additional investment beyond what is required to implement the current ANSI/EIA 748A earned value standard (ANSI, 2007).
The “controller’s dilemma” serves to answer the classic questions of journalism: who, what, when, where, and why. The story illustrates the value of earned value management in a way that is almost impossible to forget.
This paper will provide a vehicle for conveying my understanding of the value of earned value management to a wider and younger audience. It will answer, for PMI Global Congress attendees, the important question of why earned value was originally created and why it is still required today.
Hopefully, it will also provide an incentive for seasoned practitioners to add 15 minutes to their own introductory Earned Value Management classes to let their students in on the secret of the value of earned value management.
Ask anyone who has just finished his or her first introductory class on Earned Value, the following question: “Why would you want to use earned value?”
The answer is invariably, “Because it is required in my contract.”
This leads to the follow-up question, “Why do you think it is required?”
The answer will be, “I don’t know.”
These people don’t know why EVM is required, because why is not covered in the class, nor will why be answered in any “advanced” classes that may follow; even many seasoned EVMS professionals cannot enumerate the three values of earned value management.
Read the DOD Standard 7000.2, the Integrated Cost/Schedule Control System Criteria (DOD, 1967), and the EIA Standard 748A (ANSI, 2007). It is quickly evident that only one of the criteria in each one of them actually mentions earned value and that one criterion presents the equations for calculating cost variance and schedule variance. The criterion contains no information on the history of the equations, the value of using earned value management, and no guidance on how to use it. The remaining criteria detail the system requirements to implement an earned value management system (EVMS) that can be validated by the requiring agency. Work authorization, work breakdown, organizational breakdown, configuration management, baseline control, risk management, accounting, staffing, cost collection, reporting and, of course, control of the standards themselves are important for good project management and implementation of the EVMS. Nonetheless, the system criteria do not explain why the system is valuable.
PMI’s A Guide to the Project Management Body of Knowledge (PMBOK® Guide) (PMI, 2004) devotes minimal space to earned value and again presents the equations for cost variance and schedule variance and some guidance on reporting. No attention is given to the justification for the requirement or the origin of the requirement; unlike the lengthy explanations of why scheduling, cost collection, integrity, and other knowledge areas are valuable, there is no explanation of why a project manager would actually want to use earned value. Project managers are left feeling that the only reason to use earned value management is that it is required by Government contracts for some unfathomable reason. There is a startling lack of attention given to the reason why the EVMS standards exist in the first place.
Project controllers and project managers who do not understand the value of any requirement seldom fully cooperate with implementing the requirement. Not surprisingly, most of the project control personnel in government and contractor offices consider EVMS to be an onerous time-consuming requirement that lacks any return on their considerable investment in compliance.
Of even more concern are recent comments on EVM blogs suggesting that EVMS has outlived any value it may have ever delivered; nothing could be further from the truth. Considering the number of projects underway in business, industry, and government and the cumulative value of all of those projects, this is not an acceptable finding.
Most authors of texts on earned value state that to be truly proficient in implementing earned value management you must first understand its origins; then, they admit to not quite knowing what those origins were. Frequently, the earliest forms of earned value are attributed to “shop floor practices in the early 1900s.”
In the early 1900s, and even today, there are many shop practices that use the tangible values for parts, components, and processes. These practices came to their apex with the advent of value added taxes in Europe during the 1970s and 1980s. To comply with the taxes, it was mandatory to calculate the change in value at every stage of manufacturing and development.
For earned value, the history quickly flips forward to the 1950s and the implementation of PERT (Project Evaluation and Reporting Tool) and PERT/Cost (PERT with Cost Data).
I have worked with both PERT and PERT/Cost and EVMS and it is clear that PERT and PERT/Cost had little to do with the origin of earned value. There is no derivation of the equations for cost and schedule variance and no missing link to explain the leap from PERT/Cost to EVMS. PERT/Cost simply coincidentally appeared about the same time earned value management first came into use, as different teams were searching for a method to control project cost risk.
The history of EVM continues in 1967, with formalization of the MIL Standard 7000.2. Nothing ever springs into being as a Military Standard. The first clue in a search for the beginnings of earned value management comes from the NDIA DOD 7000.2 implementation guide, which says that 7000.2 was developed after a survey of industry practices; unfortunately, it does not document what those industry practices were.
I have learned earned value in different contexts from most of today’s practitioners. First, learning commercial earned value and later learning the government standard. Early in my career I became convinced that earned value was one of the most powerful project management tools available and vital to project management success. I have used earned value to steer projects out of trouble and completed many projects under budget and ahead of schedule. On at least one of these projects, I was given a zero percentage chance of doing so by the Las Vegas odds makers! Yes, the project was in Las Vegas.
I have used this understanding of earned value to design and implement three EVM systems. Each system was validated on the first review. I’ve been told that one success on first review was remarkable, two were impossible, and three apparently made me a viable candidate for speaking at PMI Global Congresses.
I first heard the term “earned value” in 1973 during a job interview. I was asked too describe what I knew about earned value, because the position I was being interviewed for would be responsible for implementing it within the construction division of an electric power company. It was the first time I had heard the words, I knew nothing about earned value, and did not get the job. Not an outcome I ever wanted to repeat, I decided to research the term. A visit to the university library revealed there were no books on the subject at that library. The librarians had never heard of earned value either. The same thing happened at the public library, and, for a while, the puzzle lay dormant.
The history of EVM continued to intrigue me. I studied management control systems at a much respected graduate business school, where earned value was never mentioned and there were no courses on earned value management. Again, no references were available in the library to research earned value; of course very little was taught about critical path scheduling either. Scheduling was considered an engineering course, not a business course. My frequent inquiries about earned value as an MBA student led to a chance conversation with a journalism intern in 1976. She told me how her father had been part of the team that invented earned value management.
I heard the term earned value again in 1981, as a consultant tasked with helping the construction division of PPG Industries implement a new computerized project control system. PPG Industries had a well-developed Earned Hours system that had been in use for over 20 years, well before DOD began writing 7000.2. Here was the first use of earned value I had ever seen. It was a commercial system. I got a thorough introduction to a non-governmental earned value system with quite a bit of heritage. The project management system PPG had purchased did not have any functions built into it to handle earned value of any kind. Fortunately, it had an expandable relational database and a report writer. PPG got the Earned Hours system they wanted, and today PPG uses an EIA 748 compliant EVMS.
A system designer working for Artemis USA told me a story that conveyed his understanding of why earned value was one of the most valuable management control techniques I would ever learn. In that 15-minute story he explained the problem EVM was created to solve and two of its primary values. Since that lesson, I have enthusiastically applied EVM on every project, large or small, required or not, personal or professional. I applied EVM because it helped me manage my projects, not because it was required.
It didn’t take long to realize that the two stories were consistent and provided the same tale from the perspective of a corporate controller who needed a better management tool and the consultants who uncovered the better tool. I combined the two stories into what I now call, “The Controller ’s Dilemma.”
When I finally learned of DOD 7000.2 in 1987, it was clear that there were significant similarities and differences between PPG’s earned hours system and DOD 7000.s. The most significant difference was that the cost variance equation was “backward”; instead of subtracting earned value from the budget, the earned hours system subtracted the budget from the earned value. We’ll see why this is significant later as “The Controller ’s Dilemma” unfolds. The differences between the earned hours system and DOD 7000.2 confirmed, for me, my theory about how earned value was first conceived.
I can’t prove that “The Controller ’s Dilemma” is the one true source of earned value. After working with dozens of Fortune 100 clients, I came to suspect that earned value management had many virtually identical origins. Many people encountered the same problem at the same time and came up with solutions similar enough and effective enough to be parts of the industry practices surveyed during the creation of DOD 7000.2. Of course, the practices ‘introduced” by 7000.2 are now known as ANSI/EIA Standard 748A.
The Controller’s Dilemma
The scene is a conference room in a large corporation and it’s the early 1950s. The room is filled with smoke. The corporation’s controller sits at a table puffing on a cigar. Assistant controllers and project managers fill the chairs lining the walls of the room nervously smoking cigarettes. A lone easel stands at the front of the room. A project manager has just placed a cardboard status report chart on the easel. He is briefing a new product development project that started earlier that month. The budget is US$400,000, divided evenly over four months (Exhibit 1).
The project manger reports that the project got under way a bit slowly and he had trouble assembling the team he wanted. Expenditures were low for the month, but the team was in place and he expected to make better progress next month. The chart uses the time honored classic accounting formula for variance:
Variance = Budget – Actual
Month 2 arrives, and the project manager reports expenditures of US$90,000 and making good progress after having a bit of trouble getting the product design finalized.
Month 3 arrives, and the project manager reports expenditures of us$ 110,000, a bit over target for the month. He had to bring in some senior personnel for the month to get the project back on schedule. He is still well within the project’s overall budget.
Finally, in month 4, the report shows US$130,000 in expenditures. The project manager reports that the senior people stayed on the project during most of month 4. The result was that the design is complete and the prototype has been turned over for testing and he is still under budget. There will be a small expenditure next week to support testing.
The chart for month 4 now looks like this (Exhibit 2):
And, then the time comes for the month 5 report (Exhibit 3)……
The project manager reports that the prototype failed testing. The design had to be revised, a new prototype was built, and the new prototype passed test and was turned over to production. The project manager is expecting praise for a successful completion. But, and, here it comes … the cost for the month was US$140,000! A total project over run of US$130,000!
The controller emits a loud explosive explicative. A thin arc of smoke follows his cigar, as the involuntarily outburst launches it in the direction of the project manager. The cigar lands on the floor in an explosion of sparks; an assistant controller rushes to retrieve the smoldering cigar. The assistant can’t help noticing that there are dozens of scorch marks on the floor near where the cigar landed. In the background, he hears his boss rumbling, “Will someone subtract nothing from the variance equation but find a way to warn me when this is going to happen?” The assistant controller knew he had a mission and apparently some discretionary funding as well.
History doesn’t record all of the various techniques that did not answer the controller’s dilemma. I suspect that PERT/COST was one of the failed attempts. Today, sixty years later, everyone in project management knows the end of the story. Very few people know how the EVM story began.
A group of consultants hired by the assistant controller actually did precisely what the controller asked; they subtracted “nothing” form the original variance equation.
The resulting equation was:
Variance = Budget - (Earned Value – Earned Value) - Actual
Regrouping the terms, they arrived at:
Variance = Budget – Earned Value + Earned Value – Actual
This equation was broken into the two equations: one for a cost variance and one for a schedule variance:
Cost Variance = Budget – Earned Value
Schedule Variance = Earned Value – Actual
Could these two new variances solve the controller’s dilemma?
Note: The cost variance equation was later flipped to become the equation everyone in EVMS is now familiar with and that eventually everyone, except the finance department, forgot about in the original variance calculation.
Let’s revisit that final project status chart but add to it an earned value analysis, for simplicity’s sake using today’s version of the variance formulas (Exhibit 4).
When could the controller have known trouble was brewing?
The answer with earned value is that trouble was obvious as early as month 1! Unlike the project manager’s reports, earned value analysis showed that this particular fictitious project was in the red from beginning to end. Extensive research into earned value analysis at the Defense System Management College has shown that it is reasonable for earned value data to predict project success or failure as early as when it is 25% complete. This is valuable information to any project sponsor who must plan ahead to cover the total final cost of a project.
Earned value analysis also provides very valuable information for the project manager. The project manager knows the earned value data before anyone else, certainly prior to meeting with the controller. There is time to take corrective action before anyone else in the organization knows trouble is brewing and perhaps enough time to never have to report trouble. Other project management research has shown that the earlier corrective action is taken, the less it costs. The US$130,000 overrun in our story may have been much smaller, had the project manager followed a different course of action; such as bringing some senior level people onto the project sooner.
Is this story true?
The details are fictitious, but, the general scenario has played out countless times in enough conference rooms throughout the world to give credence to the possibility that earned value analysis originated this way. The concept of budgeting certainly existed long before 1950. The shop floor costing was common enough practice to later evolve into another management system, known today as “operations research.” The elements for earned value analysis all existed; it merely took the spark of genius to combine them to answer the controller’s question.
It is entirely plausible that the phase “subtract nothing,” was actually the key.
No one seems to have recorded when or where earned value was first used to analyze a project. The author’s personal suspicion is that it actually happened in several places and all in the same early 1950s time frame. The NDIA introduction to Military Standard 7000.2 certainly says that the standard was developed after a review of industry practices. This indicates that more than one earned value system was in use in industry prior to December 1967.
In any event, the significance of this story is its ability to illustrate the value of earned value analysis in the corporate or agency setting and it provides a mnemonic that makes the derivation of the earned value variance formulas impossible to forget—just subtract zero and regroup the terms.
Anyone who has worked on a government project, producing Formats 1 through 5, will seriously doubt that project progress reporting has been simplified by earned value. The reason for this is that very few organizations fully understand earned value management. If a project was well understood when it was created, the earned value plan was produced by someone who truly understood its significance and the project was well managed during execution, it should be possible for a project manager to let the system create the reports. When the time comes for the management briefing, simply state, “All variances are within tolerances” and sit back down.
In reality, the process of proposing new projects seldom allows for this.
Arbitrary upper management cost “challenges” (percent reductions of proposed costs without any reduction in scope) almost guarantee that projects will run close to, if not over, the tolerances also set by upper management. None of this is due to the use of earned value. There is nothing about EVM that requires arbitrary cost challenges; in fact, earned value management is itself an argument against arbitrary changes to baseline cost values.
Until upper management learns to trust EVM and changes their habits, this value statement will stay very short.
A quick look at the five report formats in EIA 748A reveals that there is a great deal of non-earned value data being requested. Formats 1 and 2 restate the numerical earned value analysis for different audiences—WBS format for the sponsors, organization format for the organization’s managers. Format 3—Baseline Management—is important information for project management, but this is a different Knowledge Area of PMI’s PMBOK® Guide. Format 3 contains only one number relevant to earned value: the contract budget target at complete; similarly, Format 4, Staffing, contains important project management information but it is not earned value information. Many aspects of project management have been drawn together in the reporting requirements, because the EVMS criteria provided a good vehicle to get project management’s attention. Format 5, the variance analysis text, has been the subject of endless “how to” articles and still very few simple, concise variance analyses have been written.
The purpose of the EIA 748A criteria is obviously not to teach earned value, nor to show a project manager how to gain the maximum value from using earned value management. Most training courses on earned value, when teaching how to create reports, provide a single sheet of base data. A single sheet! That single sheet of data is the heart of earned value. The health of the project can be described by a single sheet of data. Remarkably, this simplicity extends to every level of the work breakdown and organization structure. EVMS is scalable to any size project or organization as long as the value of that one sheet of data is understood. All of the other complex formats and reports restate the data on that single sheet to facilitate analysis of the project by someone other then the project manager.
Cash Flow Projection
What was the controller in the “controller’s dilemma” actually interested in?
It wasn’t curiosity about how good the project manager was. The project management organization has the responsibility for hiring, training, and retaining good project managers.
The controller wasn’t an engineer interested in the details of how the project was being executed.
The controller in any organization is interested in one thing and one thing only: how much cash will be required for next month’s operations. The money managers in government organizations are not that much different. Funding limits and anti-deficiency law require them to know how much funding will be required next month, next quarter, and throughout the life cycles of the projects under their control.
The only requirement needed to obtain a cash flow projection from an EVMS where the cash flow capability is understood, is to apply the cost performance index to the projected earned value. A cash flow projection that is fairly accurate all the way to the end of the project can be produced. EVM literature is full of variations of the estimate at completion (EAC or ETC) calculations for use in producing system generated estimates at completion. It is left up to the individual organizations to work out which variation produces better projections for their organization. Amazingly, the scalability of EVM allows the cash flow projection to be produced equally well for every earned value plan at every level of the WBS and OBS, as well as at the total project and enterprise levels.
The creators of DOD 7000.2, and its successors with IC/SCS, and ANSI/EIA were not interested in cash flow, so EVM systems built solely to satisfy EIA 748A will not contain any provisions for cash flow projections. There is no realization that the earned value management system is in its essence a cash flow control system. As a result, the finance department of every organization with an EIA 748A EVMS will implement independent systems and procedures to produce cash flow projections for every project. This creates unnecessary work for themselves and every project management team. With a little bit of database programming support any EVMS can satisfy the need for cash flow projections with the touch of a button or as a standard monthly report.
Earned value management would not exist if it did not reduce the risk of doing business. EVMS from its earliest commercial implementations answered the need to manage cost risk. EVM allows early recognition of project trouble, permits the earliest implementation of corrective action to minimize cost risk and permits senior management to look into the future of the project to decide whether they need to cut their losses sooner rather than later.
Upper management has never had an interest in hearing a detailed assessment of a project’s work flow. Since the beginning of time, management has been interested in profit. In a government setting, the profit motive becomes the budget motive. The questions upper management wants to have answered remain the same: How much will the project cost and when will the money be needed? Providing (or controlling) monetary (resource) support is upper management’s role in all organizations.
An earned value management system designed with complete understanding of the value of EVM would automatically answer upper management’s cost and funding questions and allow project managers to take corrective action at the earliest possible moment.
ANSI (2007) ANSI/EIA-748-B Earned value management systems, Retrieved from http://webstore.ansi.org/RecordDetail.aspx?sku=ANSI%2fEIA-748-B
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© 2011, Chris Fostel
Originally published as a part of 2011 PMI Global Congress Proceedings – Dallas, TX