Cost overruns Flashcards
What is cost overrun?
Cost overrun can be defined as the relative inflation adjusted difference between the final and the initial estimate of the cost of a project.
It is the difference between what we thought it would cost, and what it ended up costing
What is the ongoing disagreement in the academic literature on how cost overruns should be defined?
There is a disagreement on how to define the initial estimate of the project. Flyvbjerg uses the latest available budget at the time of decision making, when the project is set in action. Flyvbjerg uses costoverrun as a measure for evaluating decision-making.
Others (Love and Ahiga-Dagbui) claims that since the scope were to change continiously, because of proggressive elaboration, the initial estimate isn’t relevant. They argue that only the last budget before project closure is a relevant reference. This means you won’t really get any cost overruns.
Why is it important to look at cost overruns?
Cost overrun can be used as a measure of how efficient and useful the project management is.
The usefullness of project management can be masured by delays, benefit shortfall or cost overruns. Cot overrun is the simplest to measure and control.
A company’s value is the sum of the value of all it’s projects, and the value of it’s project is the sum of thediscounted cash flows. If there is cost overrun the NPV gets lower, decreasing the value of the company.
Without good cost estimation that will not give cost overruns, we can also make sure that we’ll choose the correct, most profitable projects.
What are two effects on decision-making errors?
- Asymmetri in distribution of cost overruns: It is more often that there are a cost overrun than a cost underrun, there will be a higher exected cost overrun.
- Reverse-Darwinism: Survival of the unfittest. More often you will choose a project with a lower estimated cost, that will end in cost overrun, since it is estimated a higher NPV. By doing os you will also reject FN, which would have given a higher NPV. If we did choose a summetric distribution in point 1., we would still be a victim of reverse darwinismn.
What is a Kolmogorov/Smirnov test?
It is a test to find which distribution your collected data is.
How do you do a Kosmogorov-Smirnov test?
You set up your sampled data in a empirical cumulative distribution (you will need to sort all your data for this and ranking them from the probability). Then you have to choose a hypotetical theoretical distribution, which you will compare to your sampled data. Setting up the cumulative distribution of the theoretical distribution with the empirical cumulative distribution, the KS-test wants to see the maximum vertical distance between the to CDF’s.
The maximum distance, D_max, needs to be lower than the D_critical for it to be accepted as the theoretical distribution. Level of significance gives us from a table the c(alpha). D_critical is chosen from the c(alpha) divided on the root of number of samples.
What is Flyvbjergs root caues of cost overrun?
- Random errors
- Optimism bias/cognitive bias
- Strategic misreporting
What do we mean by strategic misreporting?
Project managers are intentionally deceiving and manipulating for their cost estimations for either political or economical reasons.
What type of distribution does cost overrun have in these different root causes?
- Random errors: We’ll have a distribution symmetrical centered around 0 and a mean of 0.
- Optimism bias: Positive skewness, and a mean that is not time invariant. This is because the longer in the project you are, the more the cognitive bias is removed.
- Strategic misreporting: Positive skewness and positive mean. Time invariant.
