Five things to remember when calculating the Cost of Delay
Last week, during the presentation “Project Economics Demystified”, I recommended calulating the Cost of Delay for every project/product development effort since it is useful when you have to prioritize between extra costs or a delayed launch date. We didn’t have time to go into the subject in dept, so I felt I had to make some clarifications:
#1. What is the cost of being late in your particular case? If your aim is to increase efficiency and cut costs, then the cost of dealy is most likely linear. If you deliver one month late you miss out on one month of cost savings. This was the case for the example I used in my presentation last week. However, if your project is launching a new product or service, that’s a completely different story and the Cost of Delay will depend on the market situation:
- If you have a monopoly, the cost is close to zero. The customers will wait for your product and when it finally arrives, there will be an order backlog to fill. The cash flow will suffer since the payments are delayed, but that’s a minor cost compared to the other scenarios. This is a highly unusual scenario.
- If you are on a developing market, the cost might be small because there is no big market for your product yet and one result of being late is that your competitors will carry a bigger part of the cost of teaching the potential customers about the benefits of buing your kind of product. There might even be a second mover’s advantage, but most likely you will miss out on some of the potential sales.
- The typical scenario, however, is that your sales will grow at the same rate and peak at the same time, but at a lower level since you will miss out on a chunk of potential customers because they have already chosen your competitor’s product.
- Last, but not least, there might be a real first mover advantage on your market. If the customers’ switching costs are high, your sales rate will be slower than if you had launched the product earlier.
#2 Acknowledge the difference between Lost Revenue and Extra Project Costs. Consider these different reasons for a one-month delay:
- You have to wait for a government approval that is one month late before you can launch the product. You send home the programmers and pay a penelty of Lost Revenue while waiting.
- The developers need more time than they thought. You are not only facing Lost Revenue, you will also have to pay the programmers for working one more month, thus incurring Extra Project Costs.
#3 The concept of the Critical Path: You can only refer to the Cost of Delay if the activity is on the critical path.
Although I am not a big fan of the Critical Path Method (because it encourages detailed upfront planning and a single mistake will flaw the whole plan and cause replanning) , the concept of a critial path is extremely important. A simple definition is that if an activity on the critical path is delayed by one day, the entire project will be delayed by one day.
For example: If you have the choice of either spending two weeks of optimizing your software or bying two extra servers to meet the performace requirements, you have to ask yourself if the extra development will delay the whole project, or if it doesn’t matter since you have to wait for other activities to finish anyway. If you have to wait anyway, you will not have any extra costs of delay. (You will probably have to consider the Extra Project Cost of two weeks salary for the programmers though.)
Footnote: Set Based Design is a great technique for keeping activities off the critical path.
#4 Involve the right people. Make sure that the input comes from the right people; you cannot calculate the Cost of Dealy by yourself in isolation since A) no one will trust the figures and B) they will be right by not trusting the figures, because they will be flawed. Involve the Head of Sales, the Finance Department and anyone else that can contribute to making a good estimate of the Cost of Delay.
#5 Keep it simple. Your goal is not to make the perfect model, but to get a fairly good-enough estimate that will help you prioritize. If you are spending more than an hour or two on calculating the Cost of Delay, you are probably making it too complicated.
Good luck, and please let me know if your attempt to calculate the Cost of Delay for your project and if it was of any help!
