4 Cost Estimation Techniques: Keep Your Software Budget Tight
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4 Proven Cost Estimation Techniques to Keep Your Software Budget in Check
Published:Jun 21, 2023

4 Proven Cost Estimation Techniques to Keep Your Software Budget in Check

As any software project manager knows, accurately estimating costs is as important as the development process itself. The success of a project can hinge on effective budgeting — where overshooting or undershooting the estimated cost can lead to unwelcome surprises, project delays, or even people throwing up their hands and giving up.

(We hope that doesn’t happen to you.) 

The trick to estimating costs for software engineering projects is finding a system that works for you, applying it, and then learning how to adjust the process so it gets more accurate over time. Project cost estimation — like the development process itself — is iterative.

Because let’s face it, your first attempt at estimating is going to stink.

And that’s okay.

You won’t get it right the first time. But you can get better at estimating every time. That’s the key. In this article, we’ll go over some tried-and-true strategies that will not only keep your budget in check but also minimize risks and ensure a smoother path to project success. 

Your job is to then pick a cost estimation method — whether it’s expert judgment or parametric estimating — and apply the framework over and over again until you have enough data to break down any software project.

First, figure out which cost estimation techniques you want to use. Here are four to consider.

Different Approaches to Cost Estimation in Software Development

Technique #1: Parametric Estimating

Parametric Estimating uses a statistical model to predict a project’s cost. 

Sound complex? Fair enough. (It kind of is.)

This is an algorithmic approach that uses historical data, industry benchmarks, and specific parameters like the size or complexity of the project to calculate an estimate. 

The advantage of parametric estimating is that it’s systematic and data-driven, often yielding highly accurate results for projects that are similar to past ones. 

The downside, however, is that it requires detailed, high-quality historical data and precise scoping, which may not be available or applicable for all projects — especially unique or innovative ones.

Is this the right cost estimation model for your team? It depends on your team, their capabilities, and the types of projects you’re working on. Algorithmic estimation works best (and causes the fewest headaches) if your projects tend to contain similar requirements, features, and other constants.

Technique #2: Expert Judgment

Expert Judgment uses the knowledge and experience of industry experts to determine cost estimates. These experts might be experienced project managers, senior developers, or other professionals who have a deep understanding of the project’s domain. 

Think of it like putting together a task force for each project:

  • Create a general scope for the project.
  • Convene a group of experts.
  • Educate the experts on how to estimate costs.
  • Have each expert provide a judgment.
  • Combine, aggregate, and normalize the judgments.

The advantage of expert judgment is that it takes into account qualitative factors and future trends that statistical models might not capture. But it’s also subject to human bias, and might not be as precise for complex or unprecedented projects. (It can also introduce a lot of additional work into the estimation process.)

Technique #3: Analogy-Based or Analogous Estimation

Analogy-Based Estimation is similar to parametric estimating in that it uses historical data. 

But instead of statistical modeling, it directly compares the new project to similar ones the team’s completed in the past. In other words, if it cost $100,000 to build the last app, it should cost about $100,000 to build a similar one. 

This is top-down estimation, and generally doesn’t delve deep into the specific details of the project.

This technique can be highly effective if there’s a clear precedent for the project at hand but the team doesn’t have the time or capability to build a formulaic solution. Although it will never be as accurate as more complex estimations, this framework is great for providing a general benchmark in the early stages of project planning.

Technique #4: Bottom-Up Estimation

Bottom-Up Estimation involves breaking down a project into smaller, more manageable tasks, estimating the cost of each, then adding them up to arrive at the total cost. 

How exactly you break down the work package can vary. 

You’ll generally want to have a work breakdown structure (WBS) that helps you identify all facets of the project. For example, using a system like:

  • Function points
  • User stories and story points
  • Features and functionality
  • Stages or iterations

This technique can be highly accurate, because it allows for detailed consideration of each aspect of the project. And if you’re building something that doesn’t have an obvious analogical counterpart, you can probably look at analogous costs for specific elements, features, or user stories from past projects and piece them together into an overall cost.

The drawback is that this approach can be time-consuming, and requires a deep understanding of the project’s requirements and tasks from the start. And if you miss any tasks during planning, you’ll underestimate costs.

The Importance of Accurate Software Cost Estimation

In software development, cost estimation is the process of predicting the amount of effort, time, and resources necessary to design, develop, and deploy a software product. It’s a critical step that significantly impacts project management decisions and business strategies.

A study published in the Journal of Systems and Software found that more than 60% of software projects exceed their estimated costs. That’s why you need an estimation process that relies on real-life performance data to calculate projected costs. 

Cost estimation determines the financial feasibility of a project and affects other areas including:

  • Project planning and budgeting: It aids in developing realistic plans and allocating the right budget to avoid overspending or underfunding.
  • Risk management: Accurate cost estimation helps identify potential risks and take proactive measures to mitigate them. In fact, according to the CHAOS Report, poor cost estimation is a leading factor contributing to project risk.
  • Decision making: It plays a key role in strategic decisions like vendor selection, technology stack, and resource allocation.
  • Performance measurement: It provides a benchmark to compare the actual cost against the estimated cost, facilitating project control and performance evaluation.

The Impact of Cost Overruns on Projects

Balancing quality and budget in software development is a delicate task. When costs exceed budget, the effects can be not good to say the least. 

And delivering software on time and on budget could make or break your company. (No pressure.)

Missing the mark usually leads to some combination of the following bad things happening. 

Project Delays

When costs exceed budgeted amounts, it often leads to delays in project timelines. 

Additional time is needed to secure more funding, re-evaluate project scope, or even downsize the team to reduce expenses. Delays can also occur as a result of time spent on identifying and correcting the causes of the overrun, further derailing the project schedule.

Reduced Scope or Quality

In an attempt to keep the overall cost of a project within budget, the quality of the software may be compromised. This can involve cutting features, reducing testing, or even eliminating entire parts of the product. 

Of course, this has downstream effects besides just writing fewer lines of code. 

The final product may be missing key requirements, may not hit critical business metrics, or may just not work at all as intended. It’s also possible that these changes will push work to later in the project life cycle, creating technical debt.

Stakeholder Breakdown

Stakeholders, including clients, investors, and project team members, expect projects to be completed within the proposed budget. Cost overruns can lead to a loss of trust and dissatisfaction among these stakeholders. 

Clients may question the competency of the team or the effectiveness of the project management, damaging the client-developer relationship.

For internal stakeholders, cost overruns can lead to decreased morale, increased stress, and a perceived lack of stability or control. It could also lead to turnover and further delays.

Benefits of Effective Cost Estimation for Project Management

Effective cost estimation is a key driver of software project success, offering a range of benefits that help organizations deliver high-quality products on time and within budget. 

  • Improved budget management: With an accurate cost estimate, project managers can allocate resources more effectively, reducing the risk of cost overruns. Research indicates that companies who excel in their cost estimation processes are more likely to deliver projects within their original budget compared to others.
  • Enhanced project planning: Effective cost estimation allows for more realistic project planning and scheduling. A PMI survey found that organizations who frequently meet their project objectives have an 80 percent higher chance of having an estimation process in place.
  • Increased stakeholder confidence: Transparent and reliable cost estimates boost stakeholder confidence, resulting in smoother decision-making. PMI reveals that 90 percent of stakeholders are more likely to trust and invest in a project with a well-structured cost estimation plan.
  • Risk reduction: Cost estimation helps identify potential financial risks early, allowing for proactive mitigation strategies. The aforementioned study indicates that projects backed by robust cost estimates are 10 percent more likely to meet their original goals and business intent.

The Financial Realities of Software Development Projects

The cost of software development can vary dramatically depending on various cost drivers, such as the complexity of the project, the technology used, the location and size of the team, the development methodology, and many more.

A general range might start from around $25,000 to $50,000 for small, less complex projects, and go up to $100,000 to $500,000 for medium-sized projects, and reach over $1,000,000 for large, enterprise-level software solutions. 

With stakes like that, the cost of not doing accurate budget forecasting for your software project can lead to all sorts of mishaps. The cost of maintenance can be as much as 60-80 percent of the total cost of software over its lifetime.

In fact, according to a report by the Systems Sciences Institute at IBM, the cost to fix an error found after product release was four to five times as much as one uncovered during design, and up to 100 times more than one identified in the maintenance phase.

The Financial Reality of Software Development

Key Factors for Estimating Software Development Costs

Whether you’re developing a simple app or a complex enterprise solution, the pillars of a precise cost estimate remain the same. 

From assessing the size and complexity of your project, through referencing historical data, to defining your project scope and goals and understanding stakeholder expectations, each of these elements contributes to effective cost estimation. 

Assessing the Complexity and Size of the Project

Understanding the size and complexity of a project plays a pivotal role in accurately estimating software development costs. A small project with simple functionality will cost significantly less than a larger, complex one involving advanced features or integrations. 

It’s not just about the number of screens or functions; it’s also about the intricacies behind the scenes, such as the complexity of the data and workflows, the number of user roles, and the level of customization required. These factors significantly influence cost estimation, as they directly affect the amount of effort, development time, and resources necessary for development.

Leveraging Historical Data and Similar Projects

One of the most practical strategies in cost estimation is to reference historical data and similar past projects. Known as analogous estimating, this technique uses the actual cost of previous, similar projects as the basis for estimating the cost of the current project. 

This provides a valuable starting point and helps mitigate the risk of gross underestimation or overestimation. However, it’s crucial to consider any differences between projects, such as changes in team size, technology, or market conditions, which can affect the accuracy of the estimate.

Factoring in Project Scope and Goals

Project scope and goals are other essential factors to consider during cost estimation. A well-defined project scope provides a clear vision of what the software should achieve, the features it should have, and the quality standards it should meet. 

These elements significantly impact cost, as they dictate the amount of work to be done. 

Undefined or fluctuating scope can lead to scope creep, which can drastically inflate costs. Therefore, a clear, agreed-upon scope and set of goals is fundamental to producing an accurate cost estimate.

Accounting for Stakeholder Expectations and Inputs

Finally, incorporating stakeholder expectations and inputs is critical in ensuring an accurate project budget. Stakeholders, including clients, users, and team members, can offer valuable insights into necessary features, potential risks, and other factors that could impact the cost. 

Engaging stakeholders in the cost estimation process ensures their expectations are aligned with the budget and can lead to more informed, realistic estimates. After all, a budget that doesn’t match stakeholder expectations can lead to dissatisfaction, potential project delays, and cost overruns.

How Time Tracking Tools Contribute to Accurate Cost Estimation

Time tracking tools have become an indispensable component in the toolbox of project management and cost estimation. When utilized effectively, they can improve accuracy, enhance collaboration, optimize resource allocation, and influence project outcomes positively.

Enhancing Data Collection and Analysis

Time tracking tools significantly improve the accuracy of cost estimation by providing detailed, precise time management data. These tools monitor the actual time spent on specific tasks or projects, generating data in real-time. This granular view of time usage facilitates more accurate estimates, enables managers to spot inefficiencies or bottlenecks, and contributes to better project outcomes.

Facilitating Team Collaboration and Communication

Beyond data collection, time tracking tools also play a crucial role in team collaboration and communication. By keeping everyone informed about project progress and individual task completion, these tools enable better coordination and foster transparency. When every team member understands the time spent on various tasks, it leads to more accurate cost estimation, as it gives a clear picture of the effort invested versus the progress made.

Ensuring Optimal Resource Allocation

Resource allocation and utilization are other crucial aspects that impact cost estimation, and here too, time tracking tools come to the rescue. Analyzing time tracking data helps in understanding team capacity and identifying underutilized or overused resources. By ensuring optimal resource allocation, these tools contribute to improved cost estimation, helping avoid cost overruns or project delays.

Improving Estimation and Project Outcomes

Incorporating time tracking tools the cost estimation process can have significant impacts on both the estimation process and project outcomes. By offering real-time, precise data, promoting collaboration, and ensuring optimal resource utilization, these tools enable more accurate and reliable cost estimates. The result is improved project management, on-budget projects, and better overall results.

Using 7pace to Improve Cost Estimation for Software Projects

7pace is built to help developers, managers, and business leaders make informed estimates.

No matter which cost estimation technique works best for your team, you can only get better and smarter when you have the data you need to learn and improve. 

We’ve spent a decade building the simplest, easiest, and most useful timekeeping product for software development teams.

Learn more about how 7pace can help your team track, plan, and estimate smarter.

Free eBook

Rethinking Timekeeping for Developers:

Turning a Timesuck Into Time Well Spent

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