A cynic is often described as ‘a person who knows the price of everything and the value of nothing'. This, however, is only half right when it comes to the leaders of today's complex and ambitious projects or initiatives. That is because a surprising number of projects do not have a clear price tag. This lack of budget clarity puts projects on a shaky foundation and project leaders in a tricky position.
Varying Methods of Calculation
Varying methodologies are being used to calculate the investment or cost of projects and initiatives. The result is that some projects don’t have a clear or accurate price tag. However, it is not just about the numbers (whether they are in a spreadsheet or a project planning tool).
More fundamentally budgeting and resource allocation provides an insight to the nature of planning and decision-making around critical projects and initiatives.
It is only when budgets and people are allocated to projects that the words and aspiration of strategy are met with reality. So budgets are about the alignment of strategy and execution and how the priorities of the business and its vision of success are brought to life.
Organizations have a tried and tested means of allocating, tracking and controlling budgets. In large measure that is what the organizational bureaucracy is aimed at doing. At its core is the annual budgeting cycle. Few would say that this process is perfect, but it does provide the visibility and control required to ensure the smooth daily running of a large organization.
However, when it comes to complex projects and initiatives that involve a departure from the day to day, traditional methods of budgeting and resource allocation come under pressure:
- There is typically a higher level of uncertainty in forecasting costs and results. Extrapolating from the past may not be possible – last year plus 3, or 5% is no longer the rule of thumb.
- Such projects often require the organization to ‘pay it forward' to invest in initiatives that may not generate a return for several quarters, perhaps even years. They involve investment, rather than just budgeting decisions.
- Budgeting typically takes place on hierarchical and functional lines, however complex projects and initiatives must span traditional organizational boundaries being delivered by cross-functional teams. The question ‘Whose budget is it going to come out of?‘ is a practical, as well as a political matter.
Launching Projects Without a Clear Price Tag
A lack of budget clarity makes it difficult to evaluate projects – to decide which ones should proceed and which ones should not. After all, how can an organization commit to a project if it does not know its real cost. Is the project asking for too much or too little? Without clarity, surprises and a mismatch of expectations is inevitable.
Many organizations are overloaded with projects. This results from a failure to prioritize and sequence projects based on their importance and urgency. The result is that people and resources end up being spread too thinly, with critical projects and initiatives being starved of sufficient time and attention.
If all projects and initiatives were clearly costed and their resourcing implications fully considered, many projects would not go ahead or at least would not proceed at the same time. The result would likely be fewer but more successful projects and greater business impact.
This is where using the term ‘investment’ is key – it is not just about budget or resources, but strategic investments made by the business with an expectation of future payback.
Running Projects Without a Clear Price Tag
That a project would get the ‘green light' without having a clear budget is a frightful prospect, yet it does happen. Such projects raise alarm bells for many reasons.
Most obviously, the lack of budget clarity means that tracking progress and performance is going to be a challenge. Moreover, it typically indicates:
- Deficiencies in project planning. In short, if the budget is not clear then the work to be done and the resources required are probably not going to be clear either.
- A lack of clarity or alignment regarding the other business fundamentals of the project and that includes factors such as the business need, business impact, business urgency and so on. It suggests that there have not been enough strategic conversations regarding the project and calls into question the business case justification for the project.
In short less than total clarity regarding budget or investment puts a project on a shaky foundation.
Which comes first the budget or the project plan?
Budgeting is not a separate part of the project planning process, but integral to it – it goes hand in hand with planning the work, managing risk, engaging stakeholders, and so on. Moreover, the budget is just one side of the equation – the other is payback or return. A lack of clarity re budgets suggests broader gaps in terms of planning.
It is hard to craft a budget without working out what is going to be done and how it is going to be done. So, the first step is to break down the project into its component parts and ultimately into tasks and work streams.
Step 1: chunk the budget, breaking it down into phases distinguished by meaningful milestones or deliverables.
|Phase 1||1m||Months 1-6||95%|
|Phase 2||1.5m||Months 7-15||90%|
|Phase 3||1m||Months 16-24||70%|
If you must create a budget that spans several faces reaching out into the distant (and somewhat unknowable future), then add a lower confidence level to the budget for those chunks/phases that are further out (as per phase 3 of the project shown in the table above). Among other things, your budget contingency (wiggle-room) will depend on this confidence level.
Step 2: Work phase by phase to build the costs from the bottom up. This requires by estimating the cost of each task/work stream, you can arrive at an estimate of the cost of each phase, milestone, or deliverable of the project. In this way a breakdown of the costs follows a breakdown of the work.
Below is an example of the Work Based costing of showing manpower costs estimates for phase 1 of a systems project:
A bottom-up approach is important, as those who are closest to the work are best able to accurately determine how long it will take. Accurate budgeting generally requires a high level of familiarity with the work to be done. You will note that workstream 4 accounts for almost 40% of the manpower budget above, with a confidence level of 70% and estimates of the time required to complete ranging from 12 weeks (best case) to 18 weeks (worst case) for 10 people (FTEs).
Order of magnitude: It is not unusual to find that most of the budget is accounted for by a few categories (manpower as per the example above). So, spend the most time there. What is the confidence level regarding the key spend areas – what is the confidence level regarding budget estimates for each.
Another key aspect of project planning has major implications for the budget. Project risks are a key driver of budget over-runs, so it is difficult to estimate the budget without analyzing risk. The most important risks must be factored into the budget contingency that is set. A key risk in the example above is the complexity of the work involved in workstream 4 – it involves an integration component and thereby entails a number of unknowns.
In the example above you will see the use of a three-point estimate. That means taking the average of the worst, best and most likely estimate/scenario.
Being accurate regarding costs is not the greatest challenge that project managers face, forecasting the results and their impact is considerably trickier.
In reality, the budget setting process is often an uneasy marriage of top down and bottom up. Budget parameters have often been pre-determined (e.g. last year or the last project, plus or minus 3%, 5% or something else) and we find ourselves backfilling a number rather than working from the ground-up (so called ‘zero based’ budgeting).
Validating Your Budget/Investment Model
Building the model and agreeing the numbers can be seen as two different steps. When there is agreement on the model, various numbers can be run through it to explore alternative scenarios and their implications. Maybe you need to build the model or there may be an organizational template or a comparative project that can act as a guide.
A good model makes the basis of calculation clear, including key assumptions and hypotheses regarding costs and returns. It makes sensitivity analysis easy – enabling you to explore questions such as:
- What could be achieved with 5% more or less?
- What would happen if costs rose by 3% 5% or more?
- What would be the impact if revenue / results fell short by 3%, 5% or more?
- At what point does the project stop to make sense?
Scenarios play a key role in dealing with complexity and uncertainty. They are also a powerful too in collaborative decision-making. Of course, there is a risk that the inclusion of scenarios could complicate the decision-making process, if not managed properly. Choices (if they are understood) can make a decision easier, however scenarios often require a dialog.
Exploring Options & Scenarios
Strategy is often framed as the process of choice making – e.g. the choice to proceed in one direction rather than another. Project investment decisions are about choices too. These are rarely binary – ‘fund or don’t fund’ – choices. Illuminating the full choice set or investment options or scenarios.
|Scenario A||Scenario B||Scenario C|
|Duration/Speed||15 months||11 months||9 months|
|Business Impact (5 yr)||3m||5m||7.5m|
In the example above key factors include the speed of the project and the number of people involved. More people means that different work streams can take place in parallel, rather than sequentially. For a project where time to market (or time to revenue) this has major implications for the payback. However, you will note that the confidence levels vary across the 3 scenarios shown above. Scenario C promises the greatest payback – it cuts time to market to 9 months by, what the project leader refers to as, ‘throwing bodies at the project’. However, this presents risks (notably new hires and the challenges of coordinating a larger term) and consequently results in a lower confidence rating than Scenario B.
Practical Issues that led to Budget Ambiguity
Here are some of the challenges in pinning down a project budget, some of them are about numbers, but others are political or even strategic:
- What is the scope of the project? Tying down requirements is essential, with scope creep being a key factor in budget underestimates and overruns.
- How to present various scenarios / options regarding resource requirements? For example, with Budget A you can achieve X and with Budget B you can achieve Y.
- How to impute the cost of those people working on a project?
- What is the salary cost and how is it weighted to contribute to the associated overhead?
- How to estimate the number of days allocated by project work stream and thereby to track burn-down?
- What is the transfer cost for internal services? Are some services provided free or at a discount?
- What budget are various costs going to come from? This is a particular issue for projects that are cross-functional.
- What is the acceptable time to results, revenue or payback?
- Burdening a project with the full costs may kill it dead.
- Expecting it to pay its way or to generate profit early, may kill it dead too.
- When does the budget start? Does it include all the work completed before the project gets off the ground / is approved (e.g. planning and consultation).
- Do you budget for everything from the start or budget on a phased basis? The initial phase(s) of a project afford greater clarity than later phases. However, if you don’t secure the resources at the start they may not be available later on.
- Will the full budget be sanctioned / allocated, or will it be released in tranches? For example, with 80% being released for each phase, with the final 20% being dependent on performance?
- How to hedge your bets regarding budget and resources? Specifically what type of contingency do you add in (to allow for unexpected cost over-runs, risks and setbacks? Is there padding of cost estimates or sand-bagging (or lowballing) of the revenue/payback forecasts?
Contingency figure. Like the fish tails on you Gantt Chart, the contingency figure in your budget allows your idealized project plan to adjust to reality as it unfolds. The contingency figure that you can or should apply may be influenced by:
– The risks that you have analyzed and the complexity of the project and its different parts
– The level of confidence applied to each stage of the project and the level of unknowns (confidence regarding estimate several phases or quarters out are likely to be lower)
– The standard applied within your organization
Calculating the Real or Economic Cost
If a budget seems low the first place to look is how people and their time are charged to a project. Quite often they are not. The typical response is: ‘We won't be taking on any new people for this project and will simply be using existing resources. They are not charged to the project because the company is going to be paying those salaries anyhow‘. Something similar can be heard in respect of the use of assets, equipment or overhead that are ‘already paid for‘ and ‘represents a fixed cost to the business‘.
However, it is difficult to get a real or accurate estimate of the investment required if these factors are neglected. It is particularly challenging if some projects include them and others don't.
Excluding labor and similar costs presents problems in terms of understanding the real or economic cost of a project. Labor is not free and at the minimum there is an opportunity cost for people working on a project versus doing other work. However, the issue quickly moves from economics to politics when it comes to who charges their time and at what level (especially when projects span departments and functions).
Remember Budgeting Has Multiple Objectives
In devising a project budget people are trying to achieve multiple ends:
- Plan out a project and what it would take to deliver it
- Explore different scenarios and possible outcomes (considering risks, etc.)
- Tease out the viability of a project including the return on investment
- Establish the feasibility, or otherwise, of a project
- Test the level of commitment to (as well as the level of confidence and ambition) for a project
- Engage stakeholders in the process of co-creation and ownership (via strategic conversations regarding the project – the investment and return)
- Get the project approved and secure funding
- Provide the basis for project tracking / control, including the means by which performance will be measured
- Set a project up for success – to deliver on a specific business result
As the above list suggests, there are multiple objectives to be achieved in crafting a project budget. A perfect set of numbers could be created and yet many of the above objectives not realized. This often happens with budgets that are prepared at the last minute or without sufficient consultation or review.
The process is as important as the outcome. People must be able to float around budget options and scenarios in the process of planning and dialog around a strategic initiative, or critical project. However, there is a danger that a tentative budget figure, once mentioned, can end up set in stone. A key factor is: When does an estimate become a budget?
Typically, the more people have been consulted with regarding the budget, the more robust it is likely to be. Also, the more buy-in you are likely to get – people are less likely to reject budgets they were involved in creating. However, it also increases risk, so the process by which you engage people is important:
- Be clear on what you're asking people for the perspectives on. For example, you are probably not going to revise all your numbers after every conversation, but are seeking input from a variety of perspectives into those aspects of the budget that are most important and most sensitive to risk.
- Present the scenarios, the options, the assumptions and the dependencies as the key variables – these are the real mechanics behind the numbers.
Fudging the Cost Is Easy!
Here are some reasons not to fully tie down costs and why the price tag may be left unclear:
- The budgeting process is ‘broken' with numbers being driven by finance/elsewhere, bottom up involvement is limited. Numbers are greeted with cynicism.
- Figures thrown out in the early stages of a project have a nasty way of coming back to haunt a project. The point at which an estimate becomes a budget is important.
- The longer you wait before devising a budget the more information you are likely to have. In an organization that expects accurate budget estimates and allows little room for revision of budgets this is important.
- If people knew the true cost for a project it might scare them. It forces a commitment or a decision to back a project. Doing this too early could stop the project getting a proper hearing.
- Until the project scope has been clarified and basic project estimation done, it is difficult to arrive at an accurate budget figure.
- The budget is just one side of the equation – the other is payback or return. Being accurate regarding costs is not the greatest challenge that project managers face, forecasting the results and their impact is considerably trickier.
- Tying down costs could result in the project being charged for some inputs that are presently free. For example, the time of some people involved or some of the services provided by business units.
These are best seen as reasons to slow down in finalizing a budget, but not reasons to avoid doing it altogether.
Running the Numbers Vs Playing the Game
Budgets and access to resources are as much a sociological phenomenon as they are about accounting or economics1. Competition for resources goes beyond rational economic behavior to include politics and gamesmanship – such as canvassing support, padding budgets, lowballing (sandbagging) results or hoarding resources. The result is that decisions are skewed and resources don’t always go where they should.
“When everyone else is playing games, why would you stand out as the sole voice of realism?”
Chris Bradley, Martin Hirt, Sven Smit 2
Quite often budget making is a flawed process – one that is based on a fallacy. That is our mistaken belief that we can accurately forecast and plan into the future (REF).
Predicting the budget for a project weeks or months before it starts and being tied to that figure up to a year or more later is an anachronism. Yet, organizations tend to be at their most bureaucratic and rigid when it comes to budget setting and resource allocation.
Paradoxically while organizations say that they want greater agility, the annual budgeting cycle and multi-year strategy promote the opposite. What happens when a project needs to adjust its approach or its budget is a telling indicator of agility – how long will it take to get approval, how much paperwork will be required, what committee meetings and sign-offs will be required?
Factors to consider:
Project budget should be a dynamic document, reviewed and updated regularly, however budgets quickly get locked in…
Version number – allow for multiple iterations of your budget, giving each update a version number (e.g. version 1.2) and tracking the changes so as to reveal the intelligence and dialog that has informed the numbers as they fall into shape.
Phasing and staging… Draw down….
Initial phase or pilot to get greater clarity re costs
Red team your project estimates to arrive a high confidence budget figure. This involves asking others to deliberately look for holes in your estimates, or to build an alternative estimate for comparison purposes.
Keep the timeline in mind. The timing of the project can be a key factor in budgeting and related to this the issues of resources planning/availability. For example:
- The time frame matter – delivering a project faster (with parallel workstreams) can cost more.
- Costs can be impacted if a project starts at a time when there are multiple other projects underway or key people are travelling or on leave.
- Strategy processes really are in the running for the world’s biggest zoo of frolicking biases and social distortions. Now . . . add social dynamics to the mix” from Strategy Beyond the Hockey Stick: People, Probabilities, and Big Moves to Beat the Odds by Chris Bradley, Martin Hirt, Sven Smit
- Strategy Beyond the Hockey Stick: People, Probabilities, and Big Moves to Beat the Odds by Chris Bradley, Martin Hirt, Sven Smit