PROJECT

MANAGEMEN
T
Lesson 14 Pricing and Estimates
Lesson 15 Cost Controls
 PROJECT MANAGEMENT

Lesson 13 Lesson 14
Pricing and Estimating Cost Control
With the complexities involved, it is not surprising that many business
managers consider pricing an art. Having information on customer cost
budgets and competitive pricing would certainly help. However, the
reality is that whatever information is available to one bidder is
generally available to the others.
Estimates are not blind luck. They are well-thought-out
decisions based on either the best available information, some
type of cost estimating relationship, or some type of cost
model. Cost estimating relationships (CERs) are generally the
output of cost models.
Typical CERs might be:
 ● Cost–quantity relationships such as learning curves
 ● Cost–cost relationships
 ● Cost–non cost relationships based on physical
characteristics, technical parameters, or performance
characteristics
GLOBAL PRICING STRATEGIES
Specific pricing strategies must be developed for each individual
situation. Frequently, however, one of two situations prevails when one
is pursuing project acquisitions competitively. First, the new business
opportunity may be a one-of-a-kind program with little or no follow-
on potential, a situation classified as type I acquisition. Second, the
new business opportunity may be an entry point to a larger follow-on
or repeat business, or may represent a planned penetration into a new
market. This acquisition is classified as type II.
TYPE OF ESTIMATES
Projects can range from a feasibility study, through
modification of existing facilities, to complete design,
procurement, and construction of a large complex. Whatever
the project may be, whether large or small, the estimate and
type of information desired may differ radically.
TYPE OF ESTIMATES
The first type of estimate is an order-of-magnitude analysis,
which is made without any detailed engineering data. The
order-of-magnitude analysis may have an accuracy of 35
percent within the scope of the project. This type of estimate
may use past experience (not necessarily similar), scale
factors, parametric curves, or capacity estimates (i.e., $/# of
product or $/kW electricity).
TYPE OF ESTIMATES
Next, there is the approximate estimate (or top-down estimate), which
is also made without detailed engineering data, and may be accurate to
15 percent. This type of estimate is prorated from previous projects
that are similar in scope and capacity, and may be titled as estimating
by analogy, parametric curves, rule of thumb, and indexed cost of
similar activities adjusted for capacity and technology. In such a case,
the estimator may say that this activity is 50 percent more difficult
than a previous (i.e., reference) activity and requires 50 percent more
time, man-hours, dollars, materials, and so on.
TYPE OF ESTIMATES

The definitive estimate, or grassroots buildup estimate,

is prepared from well-defined engineering data
including (as a minimum) vendor quotes, fairly
complete plans, specifications, unit prices, and estimate
to complete. The definitive estimate, also referred to as
detailed estimating, has an accuracy of 5 percent.
TYPE OF ESTIMATES
Another method for estimating is the use of learning curves.
Learning curves are graphical representations of repetitive
functions in which continuous operations will lead to a
reduction in time, resources, and money. The theory behind
learning curves is usually applied to manufacturing
operations.
Estimating Manuals
Many companies try to standardize their estimating
procedures by developing an estimating manual. The
estimating manual is then used to price out the effort, perhaps
as much as 90 percent. Estimating manuals usually give
better estimates than industrial engineering standards because
they include groups of tasks and take into consideration such
items as downtime, cleanup time, lunch, and breaks.
PRICING PROCESS
This activity schedules the development of the work
breakdown structure and provides management with two of
the three operational tools necessary for the control of a
system or project. The development of these two tools is
normally the responsibility of the program office with input
from the functional units.
ORGANIZATIONAL INPUT
REQUIREMENTS
Once the work breakdown structure and activity schedules are
established, the program manager calls a meeting for all organizations
that will submit pricing information. It is imperative that all pricing or
labor-costing representatives be present for the first meeting. During this
“kickoff” meeting, the work breakdown structure is described in depth
so that each pricing unit manager will know exactly what his
responsibilities are during the program. The kickoff meeting also
resolves the struggle for power among functional managers whose
responsibilities may be similar.
LABOR DISTRIBUTIONS
l costs in business base hours and dollars for the most recent month or
quarter. Average hourly rates are determined for each labor unit by direct
effort within the operations at the department level. The rates are only
averages, and include both the highest-paid employees and lowest-paid
employees, together with the department manager and the clerical support.
These base rates are then escalated as a percentage factor based on past
experience, budget as approved by management, and the local outlook and
similar industries. If the company has a predominant aerospace or defense
industry business base, then these salaries are negotiated with local
government agencies prior to submittal for proposals.
OVERHEAD RATES
The ability to control program costs involves more than tracking labor
dollars and labor hours; overhead dollars, one of the biggest
headaches, must also be tracked. Although most programs have an
assistant program manager for cost whose responsibilities include
monthly overhead rate analysis, the program manager can drastically
increase the success of his program by insisting that each program
team member understand overhead rates.
Assume that ATopManufacturing must write an interim report for
task 1 of project 1 during regular shift or on overtime. The
project will require 500 man-hours at $15.00 per hour. The
overhead burden is 75 percent on regular shift but only 5 percent
on overtime. Overtime, however, is paid at a rate of time and a
half. Assuming that the report can be written on either time,
which is cost-effective—regular time or overtime?
Elements of Overhead Rates
Building maintenance Consulting services Fringe benefits
New business directors Professional meetings Supervision
Building rent Corporate auditing expenses General ledger expenses
Office supplies Reproduction facilities Telephone/telegraph facilities
Cafeteria Corporate salaries Group insurance
Payroll taxes Retirement plans Transportation
Clerical Depreciation of equipment Holiday
Personnel recruitment Sick leave Utilities
Clubs/associations Executive salaries Moving/storage expenses
Postage Supplies/hand tools Vacation
PRICING OUT THE WORK
Using logical pricing techniques will help in obtaining
detailed estimates. The following thirteen steps provide a
logical sequence to help a company control its limited
resources.
Steps to Control Limited Resources
Step 1: Provide a complete definition of the work requirements.
Step 2: Establish a logic network with checkpoints.
Step 3: Develop the work breakdown structure.
Step 4: Price out the work breakdown structure.
Step 5: Review WBS costs with each functional manager.
Step 6: Decide on the basic course of action.
Step 7: Establish reasonable costs for each WBS element
Steps to Control Limited Resources
Step 8: Review the base case costs with upper-level management.
Step 9: Negotiate with functional managers for qualified personnel.
Step 10: Develop the linear responsibility chart.
Step 11: Develop the final detailed and PERT/CPM schedules.
Step 12: Establish pricing cost summary reports.
Step 13: Document the result in a program plan.
COST CONTROL
Cost control is equally important to all companies, regardless of size.
Small companies generally have tighter monetary controls because the
failure of even one project can put the company at risk, but they have
less sophisticated control techniques. Large companies may have the
luxury to spread project losses over several projects, whereas the small
company may have few projects.
Many people have a poor understanding of cost
control. Cost control is not only “monitoring” costs
and recording data, but also analyzing the data in order
to take corrective action before it is too late. Cost
control should be performed by all personnel who
incur costs, not merely the project office.
Good Cost Management Includes
● Cost estimating
● Cost accounting
● Project cash flow
● Company cash flow
● Direct labor costing
● Overhead rate costing
● Other tactics, such as incentives, penalties, and profit-sharing
 What information Cost Control provides?
● Gives a picture of true work progress
● Will relate cost and schedule performance
● Identifies potential problems with respect to their sources.
● Provides information to project managers with a practical level of
summarization
● Demonstrates that the milestones are valid, timely, and auditable
The Planning Control Systems enables:
● Plan and schedule work
● Identify those indicators that will be used for measurement
● Establish direct labor budgets
● Establish overhead budgets
● Identify management reserve
UNDERSTANDING CONTROL

Effective management of a program during the operating

cycle requires that a well-organized cost and control
system be designed, developed, and implemented so that
immediate feedback can be obtained, whereby the up-to-
date usage or resources can be compared to target
objectives established during the planning cycle.
Requirements for an Effective Control Systems
● Thorough planning of the work to be performed to complete the project
● Good estimating of time, labor, and costs
● Clear communication of the scope of required tasks
● A disciplined budget and authorization of expenditures
● Timely accounting of physical progress and cost expenditures
● Periodic reestimation of time and cost to complete remaining work
● Frequent, periodic comparison of actual progress and expenditures to schedules
and budgets, both at the time of comparison and at project completion
The first purpose of control therefore becomes a verification process accomplished
by the comparison of actual performance to date with the predetermined plans and
standards set forth in the planning phase. The comparison serves to verify that:

● The objectives have been successfully translated into performance standards.

● The performance standards are, in fact, a reliable representation of program
activities and events.
● Meaningful budgets have been established such that actual versus planned
comparisons can be made.
The second purpose of control is decision-making. Three useful reports are
required by management in order to make effective and timely decisions:

● The project plan, schedule, and budget prepared during the planning
phase
● A detailed comparison between resources expended to date and those
predetermined. This includes an estimate of the work remaining and the
impact on activity completion.
● A projection of resources to be expended through program completion
These reports, supplied to the managers and the doers, provide three useful results:

● Feedback to management, the planners, and the doers

● Identification of any major deviations from the current program plan, schedule,
or budget
● The opportunity to initiate contingency planning early enough that cost,
performance, and time requirements can undergo corrected action without loss of
resources
BUDGETS

The basis for the budget is either historical cost, best

estimates, or industrial engineering standards. The
budget must identify planned manpower requirements,
contract allocated funds, and management reserve.
Tracing the Budget Log
● Distributed budget
● Management reserve
● Undistributed budget
● Contract changes
● Undistributed budget, which is that budget associated with
contract changes where time constraints prevent the necessary
planning to incorporate the change into the performance budget.
(This effort may be time-constrained.)
● Unallocated budget, which represents a logical grouping of
contract tasks that have not yet been identified and/or authorized.
COST CONTROL PROBLEMS
● Poor estimating techniques and/or standards, resulting in unrealistic budgets
● Out-of-sequence starting and completion of activities and events
● Inadequate work breakdown structure
● No management policy on reporting and control practices
● Poor work definition at the lower levels of the organization
● Management reducing budgets or bids to be competitive or to eliminate “fat”
COST CONTROL PROBLEMS
● Inadequate formal planning that results in unnoticed, or often uncontrolled,
increases in scope of effort
● Poor comparison of actual and planned costs
● Comparison of actual and planned costs at the wrong level of management
● Unforeseen technical problems
● Schedule delays that require overtime or idle time costing
● Material escalation factors that are unrealistic
Causes of Cost Overruns
● Proposal phase
● Failure to understand customer requirements
● Unrealistic appraisal of in-house capabilities
● Underestimating time requirements
Causes of Cost Overruns
● Planning phase
● Omissions
● Inaccuracy of the work breakdown structure
● Misinterpretation of information
● Use of wrong estimating techniques
● Failure to identify and concentrate on major cost elements
● Failure to assess and provide for risks
Causes of Cost Overruns
● Negotiation phase
● Forcing a speedy compromise
● Procurement ceiling costs
● Negotiation team that must “win this one”
Causes of Cost Overruns
● Contractual phase
● Contractual discrepancies
● SOW different from RFP requirements
● Proposal team different from project team
Causes of Cost Overruns
● Design phase
● Accepting customer requests without management approval
● Problems in customer communications channels and data
items
● Problems in design review meetings
Causes of Cost Overruns
● Production phase
● Excessive material costs
● Specifications that are not acceptable
● Manufacturing and engineering disagreement