How to Calculate Cost of Delay To Know Where You Lose Money
Understand what is “cost of delay” and how it impacts your company and organisation. Learn how to calculate cost of delay and learn how much money you lose every time your team delays a project.
One challenge that every business face is deciding which project should be prioritised. Would it be in a company’s best interest to embark on a $1 million project that would take three months to finish or a 20-day project that would cost $30,000?
Choosing the best option often takes often a lot of time and resources. Unfortunately, decisions like these can’t be rushed. Which is why companies now are trying to calculate the Cost of Delay (CoD) and how it impacts them specifically in terms of finance.
Understanding the Importance of Cost of Delay
As the name implies, Cost of Delay is the financial impact that a project’s delay will have on a company. It’s how much you will lose (or how big your failure will be) if the project is not finished on a specific date. I published a thorough overview about the Cost of delay recently, but this time we’re going to delve more in the quantifying its impact.
Here’s a very simplified example of the Cost of delay – an employee caught in traffic and consequently being late to a critical meeting. Unfortunately, there’s more at stake when it comes to delays in business. It could mean higher labour cost, losing a client, a less than stellar reputation or the release of a substandard product.
How to Calculate Cost of Delay
There are several key components to consider when calculating the cost of delay, like labour cost, the opportunities lost, or the market value of the product or feature.
To determine the cost of delay, you can simply estimate how much revenue the project is expected to bring after launch.
For example, your company’s new product has been estimated to have a return of $30,000 a week. So your business loses said amount every week the product’s launch has been delayed. This means a delay of three weeks will cost you $90,000 in revenue. That’s not counting the project team’s salaries, the marketing involved and the hit to your company’s reputation.
Another way to see the damage a delay will cost is to consider Cost of Delay Divided by Duration (CD3). Here are the steps to calculating it:
- Step 1: Calculate the project’s expected profit per week.
- Step 2: Estimate how much time is needed to implement the project.
- Step 3: Divide the revenue by the estimated duration of the project.
The project with the higher CD3 value is considered more critical since it will provide a faster return of investment.
Another way of computing CoD is to follow the formula:
Total Cost of Delay = Lost Month Cost + Peak Reduction Cost
To use the formula, you have to understand how the product life cycle works and the impact of the launch date on the total revenue amount.
The product cycle refers to the rate of sales, which in turn is determined by how quickly the product is released and how fast the sales team is in advertising it to customers, getting them on board and securing sales. However, the later the product is launched, the lower the sales peak will be.
The delay and consequent lower sales peak constitute the peak reduction cost. Unfortunately, determining the exact number of the reduced peak in revenue is not easy.
Meanwhile, Lost Month Cost refers to the peak month of sales. This is the time when sales of the product are consistent or high and before it starts to decline.
One easy way to compute Lost Month Cost is to multiply the peak month of volume and the product margin. This month is actually some part of the CoD.
4 Different Types of Cost of Delay
It’s also important to know the different types of Cost of Delay (CoD) as it will have an impact on your computations.
- Fixed Date Curve: As the name implies, this relates to projects that have a fixed and stringent deadline. This means the CoD is connected to a specific time frame. For example, the project will be affected when a new law is implemented or when a TV advertisement is already scheduled to be launched internationally.
Computation of Cost of Delay in this instance is a bit more complicated. Initially, the CoD will grow at a moderate pace. However, the CoD will receive a major boost after a certain time period and will return to a minimal growth rate afterwards.
- Intangible Curve: This pertains to projects with low Cost of Delay. These are usually the projects that have low priority because they have minimal impact. This also means that CoD is virtually static as there’s little or no risk if the project is delayed.
- Standard Curve: The Cost of Delay of a project grows linearly with this type. This is the easiest CoD to compute as it does not change with the duration.
- Urgent Curve: In this type, the project has to be finished and delivered quickly so it can generate value for the company. A delay will result in a huge loss. For instance, your competitor is gearing up for a major product launch and your company has a limited time to react and compete. The Cost of Delay of this type of project will be high from the beginning of the week of the deadline and will just rise over time.
It should be pointed out that the CoD curve of a project can change. For example, one company has released a product using a newly developed, groundbreaking software. Because the company has no competition, the CoD follows a standard curve.
However, the project team receives word after a year that a competing company is developing a product with the same features and it will be released in a specific month. The previous standard CoD curve will be replaced by the fixed date curve.
On That Note…
It’s vital for companies to understand what Cost of Delay is and how to calculate it. Knowing the impact CoD will have on a business will give management greater insight on the projects in the pipeline and which ones should be prioritised. This, in turn, will help a company plan out key details like the best team for the work, the logical time frame for the product and the tools needed to finish the project on time.