What is project cost estimation? 5-step process with examples

Estimating the cost of digital products is complex and we are often bad at it. Most estimations create false expectations and lead teams to complicated situations.

In this guide, we’ll explain what cost estimation is, why it’s important, and how you can use cost estimation to make informed decisions about resource allocation, budgeting, and project timelines.

What is cost estimation?

Cost estimation involves understanding how much you need to invest to accomplish something. This works best with activities you can repeat and receive the same result.

Take a house, for example. You’ll need to pay for materials, labor, decorations, an engineer, a designer, and so on. It’s possible to calculate everything up front, which means you can get a precise cost estimation.

But, a digital product is different. We cannot calculate everything upfront, although we can have a high-level idea of what kind of investment we’re considering.

Product managers need to pitch ideas all the time. Some companies will risk making a small investment to evaluate whether to fund the initiative further. Other companies will require a cost estimation before betting on the initiative.

Such an estimate allows product managers to avoid wasting time and resources on an initiative that lacks the potential for long term success. Cost estimating gives product managers a more holistic view of a potential product, which allows for a more accurate estimation of what the product will cost.

How to calculate cost estimation

When I worked for agencies, we used to try to have highly detailed estimates for everything. That almost killed us because it took way too long. To mitigate this, we developed an estimation calculation technique designed to streamline the process.

You can create a model estimation calculator by following these steps:

1. Get a diverse team — Select experienced professionals from across different business functions, (e.g., software engineers, product managers, etc.)
2. Define ranges — Use a scale like T-shirt size. XS to XL is enough
3. Pick a reference project — Consider a project you worked on recently, take different features, and categorize them according to your scale
4. Define effort for each size — From the business functions you have (UX, UI, software engineering, etc.) define how many days each of them will need to create an XS, S, M, L, and XL feature
5. Define integration efforts — Most projects require a certain level of integration. Do the same exercise as before, except this time for the effort feature integration will require

A simple calculator like this will save you a lot of time.

You may stumble upon some projects that require phases, discovery, delivery, testing, and deployment. Estimating in phases is counterproductive. The calculation should contain the overall effort to do all the required work to complete the feature.

Now, let’s say you have a new project and a list of features to estimate. How do you start? First, check who’s available and gather a small cross-functional team together.

I like playing an estimation game that takes 1–2 hours. It goes like this:

1. The product manager writes the requirements on cards
2. The product manager prepares a board with the estimation scale (XS, S, M, L, XL)
3. The product manager gets the cross-functional team in the room
4. The first member takes the card on the top, reads it out loud, and places it where they find fit. They will say why, but there’s no discussion
5. The next team member can either take a new card and do the above or pick a card on the board, move to another place, and share why they chose that
6. The game will continue until the team says it’s ok with it

The result is a high-level estimate of the whole feature set you have. You will have ranges from best case to worst case. Once you have this information you can make an informed decision about whether the product is worth pursuing, or if the team should pivot its attention towards something with more potential.

Cost estimation example

Let’s look at a real-world example to show how cost estimation works in practice.

Imagine you’re working on a new project for a healthcare application with features such as appointment booking, secure messaging between patients and healthcare providers, and a medical history tracker.

To estimate the costs for this example project, you can follow the steps outlined above. Your cost estimation process might look something like this:

1. Assemble a diverse team of professionals, including software engineers experienced in healthcare data security and privacy, UX/UI designers with knowledge of healthcare user requirements, product managers familiar with healthcare regulations, and a domain expert in the healthcare industry
2. Define the effort ranges using T-shirt sizes (XS, S, M, L, and XL) and assign specific activities for the healthcare app. For example:
   1. XS — Small UI adjustments or bug fixes
   2. S — Implementing appointment reminders or notifications
   3. M — Designing and implementing the secure messaging feature
   4. L — Developing the appointment booking system with a calendar and provider availability.
   5. XL — Creating the medical history tracker that integrates with electronic health records (EHR) systems
3. Choose a reference project with similar features, such as a telemedicine app, and categorize its features according to the T-shirt size scale described above
4. Determine the effort (in days) needed for each role to complete a feature of each size. For example:
   1. Software engineer — XS, 1 day; S, 3 days; M, 7 days; L, 10 days; XL, 15 days
   2. UX/UI designer — XS, 1 day; S, 2 days; M, 5 days; L, 7 days; XL, 10 days
   3. Product manager — XS, 0.5 day; S, 1 day; M, 2 days; L, 3 days; XL, 4 days
   4. Domain expert — XS, 0.5 day; S, 1 day; M, 3 days; L, 4 days; XL, 6 days
5. Estimate the integration efforts for each feature size, considering data security and privacy, third-party integrations (such as EHR systems), and compliance with healthcare regulations

Factors affecting cost estimation

The digital product development space can be unpredictable. Many aspects contribute to project delays and flawed estimations that hinder the success of your products.

These miscalculations can cause bottlenecks for your team that throw off the process of the current and future products. Misallocation also can result in having to shift time and resources away from another product to fund the one you are currently working on.

Here are vital aspects to consider when trying to arrive at the most accurate estimation:

• Team experience — How experienced are the team members within the technology you’re about to use? Let’s assume a team of five people where two are inexperienced. You’ll need to have experienced professionals helping inexperienced ones
• Domain knowledge — How’s your domain knowledge? If you lack that, you will need business stakeholders to cover the gap. Their availability is critical to your progress
• Dependencies — How dependent are you on others? You can expect delays if you have dependencies with other teams, service providers, freelancers, businesses, etc.
• End users — How easily can you get in touch with end users? The more complicated, the more delays you face. In B2B, getting closer to end users is generally more complex than in B2C
• Teamwork — How long has the team been working together? With new teams, it takes a while for things to start moving smoothly

Be mindful of your scenario and adapt your estimations accordingly.

Using cost estimation for decision-making

It’s fundamental to understand that estimates aren’t commitments.

When you estimate something as a month, you’re essentially saying, “Based on what I know now, this looks like a month of work.” But, after two weeks you may realize that you need one and a half months, or maybe just three weeks. Having this understanding is critical to decision-making.

Companies have limited resources. Because of this, they must carefully pick what they will work on next. Cost estimation plays a role in it. Companies want to deliver more value in a short amount of time.

Knowing the cost estimation of something will also help you understand the kind of investment you’re talking about.

Conclusion

Cost estimation is imprecise by nature. You can be more predictable with time, but the beauty of product management is inspecting and adapting. The more you learn, the more you change.

Practice transparency. Use the estimation as a starting point, but don’t let the numbers trap you. As you discover something, share that and adapt your estimates.

Also, remember that it’s important to limit the estimations to a bare minimum. You want to invest your energy into getting the work done instead of discussing how to do it.

Featured image source: IconScout