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15 July 2013

CPI: Earned Value (EV) Can Never Exceed Planned Value (PV)


Al succeeded with his very first project!  He was so proud of his project.  The customer was delighted and the Costs Performance Index was 1.1.  Yet, the program manager only graded the project as Satisfactory.  Al is so discouraged.  What was wrong with that program manager?

My new friend Bay -- an old friend of Allen, the new Project Manager -- clearly wanted me to be sympathetic toward his friend.  And he wanted me to share his negative feelings toward the program manager.

That is a shame, I replied.  Bay was studying for PMI's CAPM exam, so I decided to turn the moaning session into a project management lesson.  But you can help Al improve his project management skills if he will learn from this.

What do you mean? asked Bay.

What do you think the CPI of 1.1 means? I asked.

Bay thought a moment and replied, Al delivered more than required?

Why? I aked.

A CPI over 1 is good, and the customer is delighted, so Al delivered even more that what was required.

I baited Bay.  Those are all good things, but too much of a good thing can be bad.

How can that be?  Bay asked.

Delivering too much value might not mean you're efficient.  It might mean you're incompetent or even unethical. I wouldn't worry about that, though.  It's impossible to create a high CPI by delivering extra value.

That doesn't make sense, Bay protested.

Do you know what gold plating means in project management?

Uh-oh.  I see what you mean, he said.  I hoped I had him hooked and ready for the lesson.

The Dangers of a High CPI

Each organization has its own expectation for accuracy in estimating.  10% is a common tolerance, but a former employer of mine expected the final estimate to be accurate within +/- 5%.
  • Since a CPI of 1.1 represents a 10% deviation from the estimate, the PM's estimating skills come into question.
  • A CPI at or above the upper control limit of 1.1 means that planned resources have gone unused.  Managers scramble to find work for their employees.  People could lose their jobs.
  • A CPI above the upper control limit means that the company set aside funds for the project that it could have used to support other investments.
  • As you will see below, plenty of reasons exist for avoiding an excessive CPI.

Extra "Earned Value" Is Hidden

Al's CPI was 1.1.  If AC at completion equaled a Budget At Completion (BAC) of $1 M, then EV must have been $1.1 M because CPI = EV/AC.  That would mean that the PV at completion was $1 M.

While EV>PV is mathematically possible, it is not practically possible.  You will see that a CPI of 1.1 at project completion can only mean that the project underspent by 9.1%.

Suppose the scope says, deliver widgets A1 through A10.  When you create the Scope Management Plan, you schedule reviews to ensure that widgets A1 - A10 get delivered. Delivery of each has a pre-assigned value that is measured in the EV.

Suppose the team delivers widget A11, as well.  The Scope Management Plan assigned Earned Value to A1 - A10.  The customer paid for them.  However, the estimate did not include A11, so the customer did not pay for it and it was not included in the cost baseline. 

Since the Scope Management Plan did not include A11, the Quality Management Plan will not check to see whether it was delivered and the Cost Management Plan has no value estimate to assign to it.  Without assigning value, you cannot measure it or include it in the EV.

EV can precede PV during the project, but it cannot exceed PV at end of project.

For a CPI of 1 at end of project, EV = AC = BAC = PV.  If EV = PV = BAC, the only way to achieve CPI = 1.1 is if AC = (0.9090... x BAC).  This is because
CPI = EV/AC = PV/(0.9091 PV) = 1.1
 Thus, a high CPI at end of project can only result from spending less than planned.

The Dangers of Too Much Value

Gold plating refers to extra value given to a customer.  A company's policy may allow delivering extra value as an investment in future business.  For example, the phone company may sell you a $200 cell phone for 99 cents so you will sign a $100/month contract for the service that goes with it.  They expect to earn back the cost of the cell phone during the life of the contract and the following contracts.

In general, however, gold plating has a negative meaning.
  • Gold plating represents areas in which the project delivers value that the customer did not pay for.  Therefore, it represents a loss to the company.
  • If the estimate did not include the gold plating, then the PM's estimating skills come into question.
  • If the Scope, Cost, and Quality Management Plans do not prevent production and delivery of gold plating, then the PM's project planning and control skills come into question.
  • Even if the project stays within budget, gold plating represents missed opportunities to cut costs and increase the company's return on investment.
  • If the PM delivers significantly extra value, it not only raises an issue of an inaccurate cost estimate, it also raises an issue of whether the Seller overcharged the customer.  This raises an issue of the PM's ethics. 
Assigning planned value to A11 could cause major problems:  Suppose the PM anticipated that the team might deliver A11, assigned value to it, and included it in the EV.
  • The team fails to provide A10 but provides A11. The Cost Management Plan will indicate an EV of 100%, even though the project only delivered 90% of the authorized scope.
  • The team provides A1 - A11.  The customer can say, "your bid included A1 - A10. Since you were able to provide A11, as well, your bid was too high. We are reducing our payment accordingly."  The FFP contract provides the Buyer no protection from this if the Buyer feels he has good evidence that he was overcharged.
  • By stopping the team from delivering A11, the PM could have cut costs and increased profits.  This represents waste and lost profits.
  • Delivering A11 might be nice for the Buyer, but it could also be a white elephant.  Suppose the Buyer is a crop duster and A1-A11 are barrels of insecticide.  If the farmers only need ten barrels of spraying done, the pilot will be stuck with the expense of storing, guarding, and disposing of the extra barrel of poison.  That represents extra liabilities to the crop duster, as well as an extra burden on the environment.  If the Buyer refuses delivery of the extra barrel, you will be stuck with it.  If the barrel gets delivered, the Buyer may sue your company for his losses.

Conclusion

PM's view the CPI the same way you look at any other measurement done as part of statistical process control.  They work to prevent high CPIs by striving to accurately estimate expenses.

PM's also view gold plating as an issue and prevent it through careful project management planning and control.


Copyright 2013, Richard Wheeler -- Permission granted for non-profit or personal use with a link to this post.
 
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2 comments:

  1. The title of this article is quite fare, while the made up story does not have sense.

    The cost performance index (CPI) should equal "1", as the scope of the project has been reached: PV = EV, therefor CIP = EV / AC = 1. So math confirms the reality and loses sense of the rest of the story.

    Measuring of CPI on the closed project does not make any sense, unless the project was terminated (also means closed) before its completion.

    While the general acceptance of the Gold plated projects is negative, they may have different flavors, though. The extras can be completed whether in favor or lose of the buyer or seller, both or neither of them. All depends on the objectives of each party, accomplished results, and the form of contract.

    Here are a few examples of Managing project by Objectives.

    1. The biggest objective of the seller was train their personnel using a new technology on the project. Right before the project completion, seller offers to buyer some extra quality that delivers great value to buyer on seller's expense, but allowed to complete the training.
    - Seller trained their personnel.
    - Buyer received more valuable product without additional cost.

    2. Seller provided extras under CR contract.
    - Seller gained on profit.
    - Buyer paid for unwanted quality.

    3. Seller provided extras under FP or PO contract.
    - Seller may have their own objectives (training personnel, testing new technology, getting a reference on a unique feature, etc.).
    - Buyer received whether wanted or unwanted quality without additional cost, while could not control the cost as it is fixed.

    There are many other stories that make world colorful; although, the Gold plated projects are bad in general. Extras are not a subject of the baseline, they are not estimated, cannot be measured and controlled, and can negatively affect the project.

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  2. My friend, thank you for your honesty. I enjoy your phrase, "make the world colorful," but I will minimize the story-telling in the future. (You were NOT rude, and I take no offense. "Faithful are the wounds of a friend, but deceitful are the kisses of an enemy.")

    As for CPI = 1 at the end of the project: You are correct that EV = PV. However, you overlooked the effect of actual costs. AC can be less than, equal to, or greater than BAC. Actual costs rarely exactly equal the budget, so EV/AC (the CPI) rarely equals 1.000 at budget completion.

    In the story, CPI = 1.1 at completion, indicating that EV = BAC, but AC = 91% x BAC.

    CPI = 1.1
    EV = PV = BAC
    Assume: AC = 91% x BAC

    CPI = EV / AC
    CPI = (BAC) / (91% x BAC)
    CPI = 1 / 0.91 = 1.1

    Confirmed: AC = 91% x BAC

    100% - 91% = 9% of the budget went unused.

    With 2-sigma estimating, half of that unused 9% could have funded another project or could have been invested at a higher interest rate.

    The PM probably failed to continuously project the variance at completion (VAC). Had he refined his estimating and reported the expected under-spending to management, management would probably have cut his budget. This would have made his CPI closer to 1 and would have allowed some of the 9% to be invested more profitably.

    Switching to gold plating: When the PM identifies extra value, he can propose it to the Change Control Board (CCB). There may be business goals that extra value serves: for example, convincing a buyer to become a return customer.

    A smart PM controls the project and does not give away value without an approved rationale and approved changes to the project baseline.

    ReplyDelete