PRICING AND ESTIMATION (CONTD.)
Pricing out the Work
Developing the Supporting/Backup Costs
The Low-Bidder Dilemma
33.1 MATERIALS/SUPPORT COSTS:
Three of four major pricing input requirements are fulfilled by
the salary structure, overhead
structure, and labor hours. The fourth major input is the cost
for materials and support. Six
subtopics are included under materials/support: materials,
purchased parts, subcontracts, freight,
travel, and other. Freight and travel can be handled in one of
two ways, both normally
dependent on the size of the program. For small-dollar-volume
programs, estimates are made
for travel and freight. For large dollar-volume programs, travel
is normally expressed as
between 3 and 5 percent of the direct labor costs, and freight
is likewise between 3 and 5
percent of all costs for material, purchased parts, and
subcontracts. The category labeled "other
support costs" may include such topics as computer hours or
Determination of the material costs is very time-consuming, more
so than cost determination for
labor hours. Material costs are submitted via a bill of
materials that includes all vendors from
whom purchases will be made, projected costs throughout the
program, scrap factors, and shelf
lifetime for those products that may be perishable.
As depicted in the Figure 33.1 below, upon release of the work
statement, work breakdown
structure, and subdivided work description, the end-item bill of
materials and manufacturing
plans are prepared. End item materials are those items
identified as an integral part of the
production end-item. Support materials consist of those
materials required by engineering and
operations to support the manufacture of end-items, and are
identified on the manufacturing
Furthermore, a procurement plan/purchase requisition is prepared
as soon as possible after
contract negotiations (using a methodology as shown in Figure
33.2 below). This plan is used to
monitor material acquisitions, forecast inventory levels, and
identify material price variances.
Manufacturing plans prepared upon release of the subdivided work
descriptions are used to
prepare tool lists for manufacturing, quality assurance, and
engineering. From these plans a
special tooling breakdown is prepared by tool engineering, which
defines those tools to be
procured and the material requirements of tools to be fabricated
in-house. These items are
priced by cost element for input on the planning charts.
The materials/support costs are submitted by month for each
month of the program. If long-lead
funding of materials is anticipated, then they should be as
items must be applied to all
materials/support costs. Some vendors may provide fixed prices
over time periods in excess of a
twelve-month period. As an example, vendor Z may quote a
firm-fixed price of $130.50 per unit
for 650 units to be delivered over the next eighteen months if
the order is placed within sixty
days. There are additional factors that influence the cost of
33.2 PRICING OUT THE WORK:
Note that the logical pricing techniques are available in order
to obtain detailed estimates. The
following thirteen steps provide a logical sequence in order to
better control the company's
limited resources. These steps may vary from company to company.
- Step 1:
Provide a complete definition of the work
- 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.
- 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.
Although the pricing of a project is an iterative process, the
project manager must still burden
himself at each iteration point by developing cost summary
reports so that key project decisions
can be made during the planning. Detailed pricing summaries are
needed at least twice: in
preparation for the pricing review meeting with management and
at pricing termination. At all
other times it is possible that ''simple cosmetic surgery" can
be performed on previous cost
summaries, such as perturbations in escalation factors and
procurement cost of raw materials.
The list identified below shows the typical pricing reports:
• A detailed
cost breakdown for each Work Breakdown Structure (WBS) element.
If the work
is priced out at the task level, then there should be a cost
summary sheet for each task, as
well as rollup sheets for each project and the total program.
• A total
program manpower curve for each department.
These manpower curves show how
each department has contracted with the project office to supply
functional resources. If the
departmental manpower curves contain several "peaks and
valleys," then the project
manager may have to alter some of his schedules to obtain some
degree of manpower
smoothing. Functional managers always prefer manpower-smoothed
• A monthly
equivalent manpower cost summary.
This table normally shows the fully
burdened cost for the average departmental employee carried out
over the entire period of
project performance. If project costs have to be reduced, the
project manager performs a
parametric study between this table and the manpower curve
• A yearly cost
distribution table. This
table is broken down by WBS element and shows the
yearly (or quarterly) costs that will be required. This table,
in essence, is a project cash-flow
summary per activity.
• A functional
cost and hour summary. This
table provides top management with an overall
description of how many hours and dollars will be spent by each
major functional unit, such
as a division. Top management would use this as part of the
forward planning process to
make sure that there are sufficient resources available for all
projects. This also includes
indirect hours and dollars.
• Monthly labor
hour and dollar expenditure forecast.
This table can be combined with the
yearly cost distribution, except that it is broken down by
month, not activity or department.
In addition, this table normally includes manpower termination
liability information for
premature cancellation of the project by outside customers.
• A raw material
and expenditure forecast.
This shows the cash flow for raw materials based
on vendor lead times, payment schedules, commitments, and
• Total program
termination liability per month.
This table shows the customer the
costs for the entire program. This is the customer's cash flow,
not the contractor's. The
difference is that each monthly cost contains the termination
liability for man-hours and
dollars, on labor and raw materials. This table is actually the
monthly costs attributed to
premature project termination.
It is important to note that these tables are used by both
project managers and upper-level
executives. The project managers utilize these tables as the
basis for project cost control. Toplevel
management utilizes them for selecting, approving, and
33.3 SYSTEMS PRICING:
The basis of successful program management is the establishment
of an accurate cost package
from which all members of the organization can both project and
track costs. The cost data must
be represented in such a manner that maximum allocation of the
corporate resources of people,
money, and facilities can be achieved.
In addition, the systems approach to pricing out the activity
schedules and the work breakdown
structure provides a means for obtaining unity within the
company. The flow of information
readily admits the participation of all members of the
organization in the program, even if on a
Functional managers obtain a better understanding of how their
labor fits into the total program
and how their activities interface with those of other
departments. For the first time, functional
managers can accurately foresee how their activity can lead to
System Approach to Resource Control
As shown in Figure 33.3 above the project pricing model
(sometimes called a strategic project
planning model) acts as a management information system, forming
the basis for the systems
approach to resource control. The summary sheets from the
computer output of the strategic
pricing model provide management with the necessary data from
which the selection of possible
programs can be made so that maximum utilization of resources
The strategic pricing model also provides management with an
invaluable tool for performing
perturbation analysis on the base case costs. This perturbation
analysis provides management
with sufficient opportunity for design and evaluation of
contingency plans, should a deviation
from the original plan be required.
33.4 DEVELOPING THE SUPPORTING/BACKUP COSTS:
Remember that not all cost proposals require backup support, but
for those that do, the backup
support should be developed along with the pricing. Extreme
caution must be exercised to make
sure that the itemized prices are compatible with the supporting
data. Government pricing
requirements are a special case.
Most supporting data come from external (subcontractor or
outside vendor) quotes. Internal data
must be based on historical data, and these historical data must
be updated continually as each
new project is completed. The supporting data should be
traceable by itemized charge numbers.
It must be kept in mind that customers may wish to audit the
cost proposal. In this case, the
starting point might be with the supporting data. It is not
uncommon on sole-source proposals to
have the supporting data audited before the final cost proposal
is submitted to the customer.
Not all cost proposals require supporting data; the determining
factor is usually the type of
contract. On a fixed-price effort, the customer may not have the
right to audit your books.
However, for a cost-reimbursable package, your costs are an open
book, and the customer
usually compares your exact costs to those of the backup
Commonly, most companies usually have a choice of more than one
estimate to be used for
backup support. In deciding which estimate to use, consideration
must be given to the
possibility of follow-on work:
• If your actual
costs grossly exceed your backup support estimates, you may lose credibility
for follow-on work.
• If your actual
costs are less than the backup costs, you must use the new actual costs on
We see that the moral here is that backup support costs provide
future credibility. If you have
well-documented, "livable" cost estimates, then you may wish to
include them in the cost
proposal even if they are not required.
Since both direct and indirect costs may be negotiated
separately as part of a contract,
supporting data such as those in the following four Tables
(33.1, 33.2, 33.3 and 33.4
respectively) and Figure 33.4 following them may be necessary to
justify any costs that may
differ from company (or customer-approved) standards
33.5 THE LOW-BIDDER DILEMMA:
There is little argument about the importance of the price tag
to the proposal. The question is
what price will win the job? Everyone has an answer to this
question. The decision process that
leads to the final price of your proposal is highly complex with
many uncertainties. Yet
proposal managers, driven by the desire to win the job, may
think that a very low-priced
proposal will help. But, hopefully, winning is only the
beginning. Companies have short- and
long-range objectives on profit, market penetration, new product
development, and so on. These
objectives may be incompatible with or irrelevant to a low-price
strategy per se; for example:
• A suspiciously
low price, particularly on cost-plus type proposals, might be perceived by
the customer as unrealistic, thus affecting the bidder's cost
credibility or even the technical
ability to perform.
• The bid price
may be unnecessarily low, relative to the competition and customer budget,
thus eroding profits.
• The price may
be irrelevant to the bid objective, such as entering a new market. Therefore,
the contractor has to sell the proposal in a credible way, e.g.,
using cost sharing.
• Low pricing
without market information is meaningless. The price level is always relative
to (1) the competitive prices, (2) the customer budget and (3)
the bidder's cost estimate.
• The bid
proposal and its price may cover only part of the total program. The ability to
phase II or follow-on business depends on phase I performance
and phase II price.
• The financial
objectives of the customer may be more complex than just finding the lowest
They may include cost objectives for total system
life-cycle cost (LCC),
for design to unit
production cost (DTUPC),
or for specific logistic support items. Presenting sound approaches
for attaining these system cost–performance parameters and
targets may be just as important as,
if not more important than, a low bid for the system's
In addition to this, it is refreshing to note that in spite of
customer pressures toward low cost and
fixed price, the lowest bidder is certainly not an automatic
winner. Both commercial and
governmental customers are increasingly concerned about cost
realism and the ability to
perform under contract. A compliant, sound, technical and
management proposal, based on past
experience with realistic, well documented cost figures, is
often chosen over the lowest bidder,
who may project a risky image regarding technical performance,
cost, or schedule.
33.6 SPECIAL PROBLEMS:
It is essential to note that there are always special problems
that, although often overlooked,
have a severe impact on the pricing effort. As an example,
pricing must include an
understanding of cost control— specifically, how costs are
billed back to the project. There are
three possible situations:
1. Work is
priced out at the department average, and all work performed is charged to the
project at the department average salary, regardless of who
accomplished the work. This
technique is obviously the easiest, but encourages project
managers to fight for the highest
salary resources, since only average wages are billed to the
2. Work is
priced out at the department average, but all work performed is billed back to
project at the actual salary of those employees who perform the
work. This method can
create a severe headache for the project manager if he tries to
use only the best employees
on his project. If these employees are earning substantially
more money than the department
average, then a cost overrun will occur unless the employees can
perform the work in less
time. Some companies are forced to use this method by government
agencies and have
estimating problems when the project that has to be priced out
is of a short duration where
only the higher-salaried employees can be used. In such a
situation it is common to ''inflate"
the direct labor hours to compensate for the added costs.
3. The work is
priced out at the actual salary of those employees who will perform the work,
and the cost is billed back the same way.
This method is the ideal situation as
long as the
people can be identified during the pricing effort.
In this regard, some companies use a combination of all three
methods. In this case, the project
office is priced out using the third method (because these
people are identified early), whereas
the functional employees are priced out using the first or
33.7 ESTIMATING PITFALLS:
There are several pitfalls that can impede the pricing function.
Probably the most serious pitfall,
and the one that is usually beyond the control of the project
manager, is the "buy-in" decision,
which is based on the assumption that there will be "bail-out"
changes or follow-on contracts
later. These changes and/or contracts may be for spares, spare
parts, maintenance, maintenance
manuals, equipment surveillance, optional equipment, optional
services, and scrap factors.
Other types of estimating pitfalls include:
Misinterpretation of the statement of work
- Omissions or
improperly defined scope
- Poorly defined
or overly optimistic schedule
- Inaccurate work
improper skill levels to tasks
- Failure to
account for risks
- Failure to
understand or account for cost escalation and inflation
- Failure to use
the correct estimating technique
- Failure to use
forward pricing rates for overhead, general and administrative, and indirect costs.
Unfortunately, many of these pitfalls do not become evident
until detected by the cost control
system, well into the project.