Cost model

Cost models are models that use simple formulas, functions or just simply equations for measuring, estimating and quantifying economic consequences, time and effort of applying required method. There is many variations of costs models, further are few examples to make it easier to understand the meaning of the cost model (Mislick & Nussbaum, 2015).

The travel cost model

The travel cost model is used when there is a need to estimate recreational use of the environment worth. It can value recreational loss or gain in examples such as closure off the beach to an oil spill or to estimate worth of improved waters quality in rivers. The travel cost model is usually applied in cases where recreation value is most important such as natural resources damage assessments and in benefit-costs analyses (Parsons, 2003).

The transaction cost model

This model is based on transaction cost theory which is known to say that a customer will choose to buy a product that have lower cost of transaction (Aubert, Rivard, 2004). In other words consumer will choose an option that helps save some money and take a better deal.

The cost estimation models

There are 5 most common cost estimation models:

• Lang method - It is a method that differentiates liquids, solids and mixed liquids/solids. It does need a lot of detail information about the project to match specified factors to the exact project.
• Hand method - This method is an extension of the Langs method. It does need even more information than the Lang method, because it is based on a system where every each of different factor needs to be used for specific equipment type such as vessels, columns or heat exchangers. It does not focus only on the type of a process but is more specified. Also it does exclude home office costs (HOC), indirect field costs (IFC), and OSBL costs.
• Equipment factored estimating - This a method used to estimate total cost of equipment used in a project. It is done by multiplying such thing as "installation factor" by individual categories of process equipment. The installation factor includes costs such as materials that are needed to install the equipment or to use in a project and other subcontracted or direct costs of labor that are associated with the project (Arafa & Alqedra, 2011).
• Parametric estimating - As a result of this process we get "Cost Estimation Relationships" (CERS) that is a set of formulary. These formulas are applied to manufacture outputs of costs for various components.
• Factor estimating - is for when the idea is generated, but not specified as any plan, and costs of implementation needs to be discovered but there is no time or possibility for detailed estimate (Arora, 2012).
• Detailed estimating also known as bottom-up estimating - This method is all about planning, scheduling and allocating resources. It is highly uneconomic from the viewpoint of time and money. It can be done by software for estimating costs or database of cost which is less time consuming, but it is only possible in case of MTO (Kumari & Pushkar, 2013). Usually it is used in case of a take-off, and then it requires a great knowledge about the activities that should be taken to reach the goal of successful planning and detail estimating. This method is usually used in the work breakdown structure (WBS) with little level and generally it goes with task lever or work package.

Examples of Cost model

1. Fixed Price Model: This cost model is used in projects where the scope, timeline, and budget are predetermined at the outset of the project, and the cost of the project is fixed. In this model, the client pays a fixed price for the entire project and the contractor is responsible for any cost overruns.
2. Time and Material (T&M) Model: This cost model is used when the scope of the project is unknown, or the project requirements change during the course of the project. In this model, the client pays an agreed-upon hourly rate for the contractor's time, and any materials used in the project.
3. Resource-Based Model: This cost model is based on the amount of resources used in the project. This model is often used in software development projects, where the cost of the project is based on the number of resources used, such as developers, testers, and other specialists.
4. Cost Plus Model: This cost model is used when the scope of the project is unknown or the project requirements change. In this model, the client pays the contractor a flat fee for the project, plus an additional fee for any additional costs incurred during the project.
5. Cost of Ownership Model: This model is used to estimate the total cost of ownership for a product or service, including all costs associated with the purchase, maintenance, and operation of the product or service. This model is often used in large-scale IT projects, where the total cost of ownership must be calculated in order to make an informed decision.

Advantages of Cost model

Cost models provide several advantages when it comes to estimating, measuring and quantifying economic consequences, time and effort of applying required method. These advantages include:

• Cost models are relatively easy to use, as most of them are based on simple formulas or equations, which can be applied quickly with minimal effort.
• Cost models provide a systematic and structured approach to analyzing the cost of a project, which can help to identify potential cost savings or areas where cost-effectiveness can be improved.
• Cost models can provide an accurate and reliable way to compare the cost of different projects, which can help to make informed decisions when allocating resources.
• Cost models can be used to measure the impact of changes to a project, such as changes in scope or duration, and can help to identify potential cost overruns or areas where cost can be reduced.

Limitations of Cost model

Cost models have several limitations that should be taken into account when using them. These limitations include:

• Unpredictability of external factors: Cost models cannot accurately predict the impact of external factors such as changes in the market conditions or political events.
• Lack of data: Cost models rely on data to be accurate, but often lack the necessary data to make accurate predictions.
• Incorrect assumptions: Cost models can be inaccurate if the assumptions used are incorrect or outdated.
• Limited scope: Cost models are limited in their scope and cannot account for all of the factors that can affect a project’s cost.
• Lack of flexibility: Cost models are usually inflexible and cannot be adapted to changing conditions.

Other approaches related to Cost model

• Life Cycle Costing - is a methodology that takes into account all relevant costs associated with the acquisition, operation, and disposal of a product or service, over its entire life cycle.
• Activity-Based Costing - is a costing model that identifies activities in an organization and assigns the cost of each activity to all products and services according to the actual consumption by each.
• Target Costing - is a cost-oriented approach to pricing that seeks to reduce costs to a predetermined level in order to reach a desired price point.
• Cost-Benefit Analysis - is an analysis of the costs and benefits associated with a project, program, or policy, in order to determine its feasibility and value for money.

In summary, cost models provide a way to measure, estimate and quantify the economic consequences, time and effort of applying a required method. Other approaches related to cost models include life cycle costing, activity-based costing, target costing and cost-benefit analysis. All of these approaches have a different focus and provide different types of insights when it comes to understanding the cost of a project or policy.

Cost model — recommended articles

Step cost — Cost per unit — Capacity analysis — Actual cost — Allocated cost — Differential costing — Cost risk — Differential cost — Product cost

References

• Arafa, M., & Alqedra, M. (2011). Early stage cost estimation of buildings construction projects using artificial neural networks, Early stage cost estimation of buildings construction projects using artificial neural networks, 4(1).
• Arora, M. N. (2012). A Textbook of Cost and Management Accounting, Vikas Publishing House.
• Aubert, B. A., Rivard, S., & Patry, M. (2004). A transaction cost model of IT outsourcing. Information & management, 41(7), 921-932.
• Kumari, S., & Pushkar, S. (2013). Performance analysis of the software cost estimation methods: a review, International Journal of Advanced Research in Computer Science and Software Engineering, 3(7).
• Liang, T. P., & Huang, J. S. (1998). An empirical study on consumer acceptance of products in electronic markets: a transaction cost model, Decision support systems, 24(1), 29-43.
• Mislick, G. K., & Nussbaum, D. A. (2015). Cost estimation: methods and tools, John Wiley & Sons.
• Parsons, G. R. (2003). The travel cost model, In A primer on nonmarket valuation (pp. 269-329). Springer, Dordrecht.

Author: Kamil Cała