“So far, we’ve lost over a million dollars. No point in turning back now. Let's see if we can recover our sunk costs." But...can sunk costs be recovered? Read on and you'll find out as we take a look at some examples of costs encountered in project management.
Types of Costs
All projects incur costs. Project costing is a key factor in making project decisions. As a project manager, you need to be aware of the type of costs that impact your project.
PMP Exam Tip: There may be some questions that’ll target your understanding of the difference between the types of costs expected during a project life-cycle.
There are five types of costs in a typical project:
Fixed costs are those that do not change throughout the life-cycle of a project.
For example, if you are constructing a road, the excavators and bulldozers are fixed costs. For software development projects, the physical development space and development computers are fixed costs to the project.
Variable costs, as the name suggests, are costs that change during the project life-cycle. Construction projects usually have a long duration and can easily span several years.
For example, in 1987, the Channel (Euro) Tunnel project begun. The objective of this project was to construct an undersea high-speed train tunnel that would connect Great Britain to France. The project was completed over a period of 3-4 years and at a cost of about 13 billion U.S. dollars. The project employed over 15,000 people and had mammoth cost overruns.This project required tremendous risk management skills. During the construction of this project there were several variable costs, such as fuel costs and labor rates.
Direct costs are expenses that come out of the project budget directly. For example, if you have outsourced some of your development work, the developers are expected to put in a specific amount of time, which is then billed for. The developer salaries are direct costs.
Indirect costs are those that are shared across multiple projects. Indirect costs are sometimes also referred to as Oversight costs. For example, in software development projects, it is common for a project manager or an architect to be partially allocated across several projects. Hence, the cost of the project manager or architect will be shared among the projects they are allocated to.
Project managers are usually an indirect cost to the project. This is because their work is to supervise. They don’t actually do the work! The people who do the work, like developers and designers, are Direct Costs to the project.
Sunk costs are those that have been incurred in a project, but have not produced value towards the project’s objectives. For example, if you are making a cup of tea and spill the milk that was to be used in the tea, then the value of the milk is your sunk costs.
Here’s another example, suppose you have hired a freelancer to develop a website in .NET. After a month, you decide that the freelancer isn’t doing a good job and reach out to another freelancer. The second freelancer convinces you that .NET is not the way to go and that your website project would be better off based on the Java platform. The cost associated with the .NET freelancer would be treated as Sunk Costs. However, if the second freelancer could build on the .NET work of the first freelancer, then your costs would not have sunk.
Ideally, platform selection in software development projects should be taken very early in the project, such as right after you Collect Requirements. As the decision impacts many other factors, such as skill and infrastructure resources, it should taken as early as possible in the project life-cycle. Sunk costs are often a consequence of not collecting requirements properly.