USPS Supplying Practices Process
Process Step 5: Measure and
Develop, Finalize, and Implement Cost Management
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
• Accountability - the plan ensures that decisions about variance
are documented and maintained in the contract file, making
decisions accountable and auditable.
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
• 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
• 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.
The following are suggested elements of a cost management plan:
• Introduction/Purpose - Describes the purpose of the cost
• Contract Management Costs - Summarizes contract
management costs. Detailed cost calculations should appear as
• 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.
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.
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.
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.
Response to Variances
Ignore the variance
Cost variance falls within the permitted range of
deviation and does not appear to be a sign of future cost
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
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
• Cost variances that are due to poor planning or poor estimating
• Costs that would normally occur have been forgotten in the cost
The Client must agree to the budget change request prior to seeking
approval of additional funds.
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.
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) 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.
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.
Earned Value (EV)
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)
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
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.
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
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
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
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
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
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.
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
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
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