Reversing the management view of project costs

The simple fact ignored by most accountants, general management and project managers is that cost is an output from the management process, and pretending cost is a manageable input is a recipe for disaster.

Profit is the difference between the price received for doing work and the cost of doing the work. If the work is accomplished satisfactorily for less then the price that will be paid for the work the surplus is profit. From the perspective of a project manager, profit is irrelevant. The project manager has no control over the price quoted for the work and apart from some administrative factions associated with documenting changes and receiving appropriate recompense there is nothing that can be done to change ‘the price’.

The project manager (and any other manager) does have some influence over the cost of accomplishing the work under their control and should use his/her best endeavours to minimise the cost. But this is not ‘cost management’ in an accounting sense. As stated in the opening paragraph cost is an output, the consequence of management actions it cannot be controlled directly and attempts to simply ‘cut costs’ will generally result in increased costs: a vicious negative spiral.

The cost of accomplishing a defined unit of work is the function of two primary inputs that can be managed to an extent:

• The cost of procuring the resources that will be used to do the work.
• The efficient use of the resources actually available to accomplish the work.

Cost and procurement

The procurement process is very much an administrative function focused on buying the right resources with the appropriate capabilities for the optimum price. To a large extent this is a market driven process, not buying the resources needed to do the work simply because the price has increased is usually not an option. In this context, the procurement process includes acquiring human resources, plant and equipment and consumable resources.

The objective of an effective procurement process is optimising value, not buying the cheapest possible resource that cannot accomplish the work effectively. It is a skilled process that should be focused on capability first and cost second. As John Ruskin pointed out some 150 years ago: “There is scarcely anything in the world that some man cannot make a little worse, and sell a little more cheaply. The person who buys on price alone is this man’s lawful prey!”

While the degree of control a project manager has over procurement may be limited; the manager has full control over making the most efficient use of the resources actually available. This is primarily a scheduling function supported by capabilities in the areas of leadership, motivation and management.

Cost outcomes are optimised by making 100% effective use of 100% of the available resources 100% of the time. To achieve this objective, the planning processes needs to focus on what the available resources can actually achieve, not some theoretical schedule based on a desirable resource mix that does not exist. This is the concept underlying schedule density [PDF].

If the available resources cannot accomplish the work, procurement is required to augment the resource pool. If there are excess resources, the planning process should identify when they can be efficiently transitioned off the project.

These primary functions are supplemented by a number of secondary issues that impact cost. These include:

• Risk management: There is a need to balance the costs of reducing risks with the contingencies needed to adequately allow for the risk.
• Quality management and the cost of quality: Balancing the cost of processes to ensure quality is achieved with the value of the quality product and the cost of quality failures. These concepts are discussed in the context of project communication and stakeholder management.

True cost cutting

Buying the right resources with the right skills and capabilities is by far the cheapest option in the long run. Unfortunately, the typical management reaction to a poor cost performance is to ‘cut costs’, which is typically achieved by sacking staff, usually from non-productive roles such as scheduling, administration and quality assurance. The immediate effect is a reduction in outgoings; the ultimate consequence is an increase in costs caused by inefficiencies, failures and re-work leading to a further loss of profits that result in another round of cost cutting until the organisation fails!

Staff in administration and support functions can be reduced if the processes they are responsible for are removed first. There are a lot of redundant or useless bureaucratic processes in most organisations that can be profitably eliminated but the sensible approach is firstly eliminate or simplify the process and then make efficient use of the available resources for the remaining work reducing headcount where appropriate.

Assuming the manager is making efficient use of the available resources (the second key point above) reducing staff without reducing process simply makes the processes even more inefficient and costly, and a greater drag on productive work. The skill is identifying genuinely redundant processes, processes that can be simplified or improved and essential processes: this takes time, needs skilled people and in the short term will increase costs to achieve real savings in the longer term by optimising the use of resources.

Measuring the cost output from a project or management function is valuable; it provides a direct insight to the overall health of the process being measured. But if the information shows a cost overrun, don’t start looking for ways to ‘cut costs’. Look for the underlying cause of the problem and focus on improving that; 90% of the time it will either be a procurement issue, a resource utilisation/scheduling issue or a process issue. If there are deficiencies or inefficiencies fix the problem and you will achieve a sustainable reduction in costs.

If the system is working well then the price was wrong and you need to deal with that unpleasant fact of life rather than making the problem worse by ill-advised short-term cost cutting that inevitably creates greater inefficiencies and higher costs in the longer term. It may not be a pleasant experience but you don’t need to make the situation worse.