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USPS Supplying Practices Process Process Step 5: Measure and Manage Supply

Develop, Finalize, and Implement Cost Management Plan

Effective cost management ensures that a project is completed on time and within budget. It serves as the critical link between project performance and budget, as the project enters Process Step 5: Measure and Manage Supply. Specifically, cost management helps control cost by monitoring the relationships between the earned value and the actual cost. Earned value (EV) refers to the budgeted cost of work performed for an activity or group of activities at a given point during the project. Earned Value Management (EVM) is a methodology used to measure and communicate the real physical progress of a project, taking into account the work completed, the time taken, and the costs incurred to complete that work.

A cost management plan supports cost management efforts by identifying the processes and procedures used to manage costs throughout the contract's life. The Pricing Analyst is responsible for the development of the cost management plan. The Item Manager will play a significant supporting role, anticipating possible resources and inventory changes that will influence cost.

A cost management plan ensures:

Guidance - the plan guides the Contracting Officer in determining how cost variances are managed and establishes any contingencies for absorbing overages.

Consistency - cost variances are managed with the same procedures throughout the contract.

Control - the Contracting Officer will analyze any cost variance before a decision is made regarding administration of the contract.

Accountability - the plan ensures that decisions about variance are documented and maintained in the contract file, making decisions accountable and auditable.

Develop Cost Management Plan

The cost management plan is developed using the purchase plan and the following resources generated during Process Step 2: Evaluate Sources:

Statement of work (SOW) or other description of the contract requirement produced during the Start Request for Proposals (RFP) Development topic of the Prepare Project task and the Review and Finalize Request for Proposals (RFP) topic of the Perform Solicitation-Related Activities task - indicates Client expectations in terms of quantity and quality, both of which affect cost

The latest total cost of ownership (TCO) estimates produced in the Update/Refine Total Cost of Ownership (TCO) Analysis topic of the Prepare Project task - estimates total contract cost

Funded budget as a result of the Formulate Project Budget and Request Funding topic of the Prepare Project task - provides the allowable cost (assuming that budget does not need to be changed)

Results of activity-based costing (ABC) analysis performed during the Perform Value Chain Mapping and Analysis topic of the Prepare Project task - allows the Pricing Analyst to better allocate costs associated with specific cost drivers at various stages of the contract

Life-cycle support plan developed during the Develop Life-cycle Support Plan topic of the Develop Sourcing Strategy task - clarifies the project's lifespan and enables the Postal Service to reduce complexity, decrease life cycle costs, and focus all efforts toward providing best value to the Client

The cost management plan describes how cost variances will be managed, should they occur. Cost variance refers to the difference between actual cost and earned value. The plan outlines the permitted range for cost deviation and response measures should cost deviate beyond the permitted range.

The cost management plan can be formal or informal, detailed or broad, depending on the complexity of the contract. The Contracting Officer must review the cost management plan regularly to ensure that its guidelines continue to be appropriate throughout the duration of the contract.

Outline for Cost Management Plan

The following are suggested elements of a cost management plan:

Introduction/Purpose - Describes the purpose of the cost management plan

Contract Management Costs - Summarizes contract management costs. Detailed cost calculations should appear as appendices.

Potential Causes of Variances - Defines permitted range for variances, and lists the factors specific to the project that could lead to variances.

Identification of Variances - Describes the procedures that will be used to identify variances.

Response to Variances - Describes the mechanisms to be used to resolve cost variance problems, including contingency plans to cover increased costs.

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Variance Definition

The Pricing Analyst is responsible for determining the range by which cost will be permitted to deviate from budget. Cost variance (CV) is calculated by comparing the actual cost of the work (AC) with the earned value (EV). Cost variance is typically expressed as a ratio or percentage. The formula is:

CV = [(EV - AC) / EV] x 100

If the result is positive, the project is experiencing an "underrun." If the result is negative, the project is experiencing an "overrun."

The permitted range of deviation of actual cost from budget, or earned value, may be dependent on:

Particular phase of the contract

Length of the contract phase

Length of the entire contract

Nature of the task or products being estimated

Perceived accuracy of the estimate

Figure 5.1 illustrates the permitted range of deviation as falling between the actual cost and earned value at any given point in the contract life cycle.

Figure 5.1

Permitted Range of Deviation

image of Permitted Range of Deviation

The permitted range of deviation may vary from project to project because of differences in scope and period of performance. For many purchases, variances are permitted to change over the contract duration because of the difficulty of forecasting costs accurately for long-term contracts. For manufacturing projects, allowed variances may be fixed over the duration of the project life cycle. For projects that involve research and development, for example, larger deviations may be allowed during the earlier phases of the project. However, in general, because the risk for any project decreases as time goes on, so should the allowed variance.

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Response to Variances

The cost management plan outlines how variances should be managed. The four main options are to:

Ignore the variances

Make functional modifications to the project

Replan the project

Redesign the product

Whether a cost variance falls within the permitted range of deviation will dictate the response measures. The choices available to manage a cost variance vary in terms of how drastic they are, how much work they require, and how much they change the contract. Ignoring the variance or making functional modifications are mild solutions. These choices require little or no work and make minimal changes to the project, if any. Replanning or making changes to the product scope are more drastic solutions that require a great deal of work and make substantial changes to the project. The contract management plan should anticipate situations that may necessitate each of the above options. Figure 5.2 suggests when each option should be used.

Figure 5.2

Response to Variances

Action Condition
Ignore the variance Cost variance falls within the permitted range of deviation and does not appear to be a sign of future cost problems.
Make functional modifications to the project Cost variance is within the permitted range, but could potentially grow or become a problem in the future.
The modifications are small changes to the project that can save time and money.
Replan the project Cost variance is outside of the permitted range.
The Client or Contracting Officer attempts to replan the project without changing the project scope. This means finding less-expensive ways of doing things (e.g., less-expensive resources, contracting out).
Redesign the product Redesign only if replanning is not sufficient to bring variance back to the permitted range.

Project replanning and product redesign involve major changes to the project. Both approaches require an assessment of the impact on the overall product quality and its ultimate usability by the Client. Taking either of these approaches too far could render the product or service substandard.

When actual cost deviates from earned value, it may be necessary to change the budget, rather than adjusting costs to match a previously determined monetary ceiling.

The following are valid reasons to change the budget:

Change to the product or service that will have an impact on cost

Change to the project scope that will have an impact on cost

Major, unforeseen changes to the costs of resources or materials

The following are not valid reasons to change the budget:

Cost variances that are normal and based on accurate estimations

Cost variances that are due to poor planning or poor estimating

Costs that would normally occur have been forgotten in the cost management plan

The Client must agree to the budget change request prior to seeking approval of additional funds.

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Finalize Cost Management Plan

When finalizing the cost management plan, the Contracting Officer should work with the Client to ensure that the planned variance responses are realistic and that they understand cost variance implications (e.g., if it would be possible to lower labor rates or adjust the scope and quantity to reduce the financial impact of a cost increase). The Client is responsible for the final cost management plan, including obtaining applicable reviews and approvals.

Implement Cost Management Plan

During the contract management process, the Contracting Officer reviews the cost management plan regularly to ensure that its guidelines continue to be appropriate throughout the duration of the contract. The Pricing Analyst closely monitors the cost variance to ensure that significant variance is addressed appropriately and in a timely manner. The Item Manager informs the Pricing Analyst of any anticipated resources and inventory changes, and the Pricing Analyst updates the cost management plan accordingly.

Several techniques are available for measuring cost performance:

Cost variance (CV)

Earned value management (EVM)

Cost performance index (CPI)

Cost Variance (CV)

Cost variance (CV) is the most basic performance measure, defined as the difference between planned costs and actual costs. CV is calculated by comparing the actual cost of the work (AC) with the earned value (EV), typically expressed as a ratio or percentage:

CV = [(EV - AC) / EV] x 100

The goal of calculating cost variances is to provide the basis for earned value management. The Pricing Analyst must understand the problems behind variances and the action that will correct any problems.

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Earned Value Management (EVM)

Some costs are incurred by tasks that are incomplete and have not yet earned any value. These costs are considered during cost analysis, but are not used when assessing the current earned value to the project. Earned value management (EVM) is perhaps the most useful activity in cost control because it combines costs and the schedule into one indicator. EVM shows how much the project is physically accomplishing in terms of both cost and time, giving management a more accurate and timely report on project progress. Earned value (EV) is the cost originally budgeted to accomplish the work that has been completed as of the analysis date. It answers the question, "How much work has actually been completed?"

EV is calculated from the measured work completed and the budgeted costs for that work:

EV = (percentage of project completed) x (project budget)

Figure 5.3 illustrates EV (represented by "$") as being associated with the percentage of work completed at various points throughout the project.

Figure 5.3

Earned Value (EV)

Figure 5.2 drawing of earned value

Actual cost (AC) is what it actually costs to accomplish all the work completed as of the analysis date. It answers the question, "How much have we actually spent?" This is usually determined from the organization's accounting system or can often be approximated by multiplying the number of people by the number of hours, days, or weeks worked.

AC = [(actual hours incurred at the task level) x (individual resource cost)] + sum (actual expense amounts for the task)

Planned value (PV) is the total budgeted cost up to the analysis date. It answers the question, "How much did we plan to spend as of this date?" A variant of this question is, "How much work should have been completed by this date?" PV can be computed from the project plan, or it can be approximated by multiplying the total budget by the fraction of total project duration at the analysis date. For example, if the project budget is $100 and 20 percent of the project's time has elapsed, the approximate PV is $20.

PV = [(task % complete) x (baselined estimated hours) x (individual resource cost)] + sum (baselined estimated expense amounts for the task for all baselined expenses with actual expense dates)

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Cost Performance Index (CPI)

The cost performance index (CPI) illustrates how efficiently a project team is accomplishing the completed work. CPI is determined by calculating the ratio of earned value (EV) to the actual cost (AC).

CPI = EV / AC

When the CPI is measured periodically, the CPI figures can be plotted in a line graph that illustrates trends over the life of the project (known as a "trend analysis").

Schedule Performance Index (SPI)

The CPI is often reported along with the schedule performance index (SPI). Both CPI and SPI are measures of efficiency, but the SPI is the ratio of earned value (EV) to planned value (PV), or budgeted costs.

SPI = EV / PV

For example, an SPI of 0.75 means that the project has earned only 75 percent of the value that was anticipated to have been earned.

Rating Performance

CPI and SPI are used to rate the cost and schedule performance of a project. A poor rating provides a warning signal, allowing for corrective measures to be taken at the early stages of issue development. If the index is:

Equal to 1.0 - performance is exactly as planned

Greater than 1.0 - performance is better than planned

Less than 1.0 - performance is poor

Estimate at Completion (EAC)

The estimate at completion (EAC) is a calculated prediction of the total costs of a project at completion, based on performance to date. The Pricing Analyst calculates the EAC when assessing the EV for a project, as part of a periodic evaluation. The EAC is the Pricing Analyst's educated guess regarding the total cost of a project. Before calculating EAC, the Pricing Analyst should determine how future cost variances may compare with current cost variances, because the formula differs based on the assumption about future variances.

As with other outputs, the periodic assessment of the EAC will contribute a vital part of the project's history. The EAC is a useful tool for project management and is primarily used to:

Indicate the expected cost of the total project

Estimate the total costs of an activity or groups of activities

Provide the best estimate of potential project profitability

If the current EAC for any project indicates potential for cost overruns, the Pricing Analyst must assess cost variances to anticipate whether the overruns will recur in the future. The Pricing Analyst is also responsible for checking the original cost estimates to determine whether the estimates were inaccurate and require revision.

In addition to future cost variances, the Pricing Analyst also needs to know the budget at completion (BAC), which is the sum of all budgets established for the contract:

BAC = (baselined estimated hours assigned at the task level x individual resource cost) + sum (baselined estimated expense amounts for the task)

Generally, the EAC can be calculated in four different ways, depending on whether the CPI is readily available and on assumptions about future cost variances.

The standard formula for calculating EAC, when CPI is not available, is based on the project's cost performance to date, or the ratio between actual cost and earned value, as part of the budget at completion. This formula is used when current cost variances reflect future variances:

EAC = (AC / EV) x BAC

If the CPI is available, simply divide it into the total budget at completion. This is presented in the second formula for calculating EAC:

EAC = BAC / CPI

The third formula combines actual costs to date and the estimate to complete (ETC). The ETC is the total of all estimated costs of work that has not yet been performed, or the difference between budget at completion and earned value (i.e., ETC = BAC - EV):

EAC = AC + ETC

This approach is most often used when:

Past variances would have continued to occur into the future

Original estimates have been revised significantly

The revised estimates are deemed accurate

The final formula that can be used to calculate the EAC adds the actual-costs-to-date to the expected earned value of the work not yet completed. To find this "future earned value," simply multiply the PV by the percentage of work that has not yet been performed:

EAC = AC + (PV x % of work remaining)

This approach is most often used when the variances to date are seen as atypical and the project team expects that similar variances will not occur in the future.

Whichever method the Pricing Analyst uses to arrive at a final estimate, EAC can be used to calculate the variance at completion for the project. The final variance can be expressed as a dollar amount or as a percentage. It is commonly seen as a ratio of the total variance, or the difference between the budgeted and estimated cost at completion of a project, to the budget at completion:

VAC = (BAC - EAC) / BAC

For a project with a BAC of $75,000 and an EAC of $85,000, the variance at completion would be $10,000. Expressed as a percentage, the VAC would be $10,000 divided by $75,000. This project would be 13 percent over budget.

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Revised Cost Estimates and Budget Updates

If early measurement of cost efficiency reveals that the project is going to have trouble remaining within budget, the Pricing Analyst will need to revise the cost estimates and update the overall budget as required.

Preliminary estimates that were set during the planning stages of the project may need to be revised. The Pricing Analyst should consult the latest total cost of ownership (TCO) estimates produced in the Update/Refine Total Cost of Ownership (TCO) Analysis topic of the Prepare Project task of Process Step 2: Evaluate Sources. In some cases, changes in cost estimates would require updating the budget. Budget updates involve a change to the approved cost baseline and may not be performed without approval by the Client.

Contract Review

At the end of a contract, the Pricing Analyst gathers all of the cost management documentation and evaluates cost management procedures. Documentation related to project cost management includes the cost management plan, budget reports, performance analyses, budget change requests, and progress updates. The Contracting Officer should prepare a summary document that confirms that all cost control decisions for the project adhere to quality guidelines. Outputs such as revision to the budget and estimates at completion should be used for quality and time management purposes to ensure the overall success of the project. They can also be used as inputs for similar projects in the future. The summary report and other documentation must be included in the contract file.

The lessons learned during cost control efforts should be posted to the Postal Service intranet knowledge site. The lessons-learned document includes:

Main causes of cost control variances

Reasons behind the corrective action chosen

Alternative actions in future projects

For example, this document might indicate that changes of project scope caused the greatest variance and that poor project team performance and lack of detail in some planning areas caused cost overruns. In future projects, better expenditure detail in the planning phase and more experienced team members could be leveraged to improve performance. The Contracting Officer must share lessons learned with the Purchase/SCM Team and the Client and will archive them for future reference. Specific guidance on communicating lessons learned is discussed in detail in the Share Lessons Learned topic of the Manage Delivery and Contract Performance task of Process Step 5: Measure and Manage Supply.

The purpose of cost management is to help ensure project objectives are achieved. By documenting the lessons learned and completing project closeout activities, the Purchase/SCM Team will help ensure achievement of project goals.

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Other Topics Considered

Start Request for Proposals (RFP) Development topic, Prepare Project task, Process Step 2: Evaluate Source

Update/Refine Total Cost of Ownership (TCO) Analysis topic, Prepare Project task, Process Step 2: Evaluate Sources

Formulate Project Budget and Request Funding topic, Prepare Project task, Process Step 2: Evaluate Sources

Perform Value Chain Mapping and Analysis topic, Prepare Project task, Process Step 2: Evaluate Sources

Develop Life Cycle Support Plan topic, Develop Sourcing Strategy task, Process Step 2: Evaluate Sources

Review and Finalize Request for Proposals (RFP) topic, Perform Solicitation-Related Activities task, Process Step 2: Evaluate Sources

Share Lessons Learned topic, Manage Delivery and Contract Performance task, Process Step 5: Measure and Manage Supply

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