In our earlier posts, we explored abuses of estimates, and then the need for the estimates in the business prioritization or what projects shall we undertake, and securing the resources to accomplish the objective.

Business Case

In the prior blog we discussed the connection between the estimates and the business case for the work.  The business case, as we have seen, compare the costs for undertaking the project against the return or income generated.  some of these comparative approaches (IRR) allows the organization to compare the proposed project against other investments the organization could otherwise undertake with this amount of money, but in all cases we are trying to understand if the proposed project is prudent use of the organizations resources or if it is a low return and high risk endeavor.  We wold not want to spend $1Million to make $250 Thousand.

Estimates and Gate Reviews

We will derive the estimates, but our organization may have project management controls to periodically review progress and compare the expected expense to the actual for a segment of the project.   This is one of the reasons for the “stage gate” approach.  At the end of the stage, the budget, the expected accomplishments are then compared to the actual expenditures and accomplishment (Earned Value Management- Schedule Variance and Cost Variance for example) are reviewed and critiqued.  The affirmation that our expected deliveries have been met, and the cost is within the range of expectation, then another way point of money will be allocated to the next project segment.   If it looks like the project cannot deliver, or the expense is too high, that is the spending for this chunk of the work is too high, we may kill the the project, reduce the scope, or accept the new estimates to complete (performing a new IRR or ROI calculation on the new projected costs).  This is where the concept of sunk costs come into the picture.

Sunk Cost and Estimates

Sunk cost, are costs that have been incurred but cannot be recovered. In the case of our fore mentioned project in which evidence indicates we are exceeding the expected expenditures (estimates) and the business case is now in question, the cost to deliver to that first gate is sunk costs.  Nothing we can do will bring that money back.  If we terminate the project, we lose the money spent. If we continue, this money should be considered as part of the project expenditure (estimates), because, well, the expense was incurred on behalf of the project.  However, some people will not include this expenditure in the future business calculations, because, that money is already spent.  This leads us to the sunk cost fallacy:

The Misconception: You make rational decisions based on the future value of objects, investments and experiences. The Truth: Your decisions are tainted by the emotional investments you accumulate, and the more you invest in something the harder it becomes to abandon it [1]

It is difficult to determine how to handle this dilemma, should you continue the project, or should you terminate?  To be sure the potential loss of the investment so far, loss because if you terminate the project now, you may not get anything out of the work while paying for it.   There are pressures to continue the project, and one way to do that, is to exclude the dollars presently spent from the business expense, as that money is lost. The project may become a money pit with each gate indicating costs are beyond the business case, yet we are compelled to continue because look how much we have spent on this project, to quit now, means all that money is lost for nothing.

[1]  https://youarenotsosmart.com/2011/03/25/the-sunk-cost-fallacy/ last accesed  9/25/2018