In today's competitive environment, every dollar counts and organizations cannot afford to remain ignorant about true project costs. Fortunately, there are a few formulas that help you track and analyze project cost and to estimate projects with increasing accuracy in the future.
Creating An Effective KPI
Key performance indicators (KPIs) measure progress toward a strategic goal. Let’s use Martin Luther King Jr. as an example to illustrate this concept. He had a morally compelling vision: equality and peace between different races. Your business needs a vision as well, and the strategic goals you set as well as the projects you take on should aim towards fulfilling this vision. King's strategy for achieving his vision was nonviolent protest. A sample KPI for measuring the success of this strategy could be ‘number of violent incidents per protester.’ King could have pushed his organization to minimize this number over time. Regardless of your vision, the closer you get to identifying it and developing a clear strategy and calculable KPIs, the more successful your projects will be.
It is important to narrow your focus, so unless your company has 100 strategic goals, you should not have 100 KPIs. Ten KPIs can be effective, five KPIs are even better, and one KPI is optimal. The KPI you choose must also be measurable. "Make clients more successful" is useless as a KPI without some way to measure their success. KPIs are often tied to strategy through techniques such as the ‘Balanced Scorecard,’ but they don’t have to be as complicated as that to be useful and effective. As with most things, simplicity increases efficacy.
A KPI is a ‘SMART’ goal, which means it must be Specific, Measurable, Achievable, Relevant and Time-Based. Let's say that you set the following goal for your team: "Increase average revenue per sale to $10,000 by December." 'Average revenue per sale’ is the KPI that you would measure in order to determine success or failure. The goal would not be SMART if it wasn’t an achievable goal. It would not be SMART if the word ‘December’ was left out either, or if it was not relevant because the team you are holding accountable is a portion of the organization that has nothing to do with sales or marketing, like HR.
Leveraging KPIs for Cost Analysis
Next I would like to discuss some useful KPIs that are easy to calculate, yet will make a huge impact on your projects and revenue.
1- Billability
Billability or utilization rate refers to the percentage of time in a given period during which an employee or set of employees are working in a revenue-producing capacity. Utilization rate can be found by the formula B/T, where B = billable hours for the employee or group in the period and T = all hours worked by the employee or group in the period. Most organizations try to keep utilization rates above 70 percent or so. The higher the rate, the better the results until you’ve reached a point where necessary administrative tasks are not being accomplished. If this occurs, you'll know that you have pushed it too far and need to regroup.
Knowing not only how many hours are being spent on a particular project but also what percentage of that time is billable to the client is one key way to understand complete project cost. The more work that employees spend time on that is not billable, the more the project will cost. If you use this KPI consistently, you will be able to identify unproductive work and find ways to minimize it successfully.
2 - Adherence to Estimate
Accurate project estimation is another component that is crucial in keeping costs down and stakeholders happy. The KPI you want to minimize here is defined by the formula [(E-A)/E], where E = estimated hours to complete project and A = actual hours used to complete project. If you can keep this number as close to zero as possible, you know that you are doing a good job in estimating projects. If not, it is important that you realize it now and take steps to address it. Improving this number can be difficult for some companies until they understand a simple truth about most projects, which is that similar projects often have a strikingly accurate ratio of early phase cost to overall project cost. In other words, the early phases of a project, commonly referred to as ‘requirements,’ ‘design,’ or ‘specification,’ can often give you a clue as to the length of the entire project. Let’s say that after carefully tracking time on a batch of similar projects you find that the first two phases take approximately 10% of the project time. You can then use that data to predict the length of future projects. We’ve found this project estimation technique to be extremely accurate, regardless of whether your company’s magic number is 3% or 30%.
3 - Percentage of projects profitable
Why do we track project costs in the first place? The answer is simple—to guarantee that every project undertaken and executed is bringing in a profitable ROI for the organization. This KPI, “percentage of projects profitable,” can really jumpstart your business and ensure that you are taking on the right projects. Unfortunately, most companies have projects going on at any given time that actually lose money for the company. Due to an inadequate understanding of costs, many of these go unnoticed. Yet all you need is direct and indirect per-project cost data along with revenue data to gauge per-project profitability, allowing you to make every effort to maximize this particular KPI. The formula is:
# of profitable projects / # of projects
Understanding true project cost should be an integral part of every organization's project management methodology, but many companies do not even know where to begin. With the right data and a few powerful KPI formulas in hand, cost engineers can enlighten the organization and empower them to be selective in the projects they choose. Not only that, but project estimation becomes substantially easier when you keep track of the length and scope of past projects, which will save you time and money as you go.
