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PRICING AND ESTIMATION
BROAD CONTENTS
Computerized Software Packages
Pricing and Estimating
Global Pricing Strategies
Types of Estimates
Pricing Process
31.1 COMPUTERIZED SOFTWARE PACKAGES:
It has been seen that over the past ten years there has been an
explosion in project management
software packages. Small packages may sell for a few thousand
dollars, whereas the price for
larger packages may be $70,000.
Computerized project management can provide answers to such
questions as:
- How will the
project be affected by limited resources?
- How will the
project be affected by a change in the requirements?
- What is the
cash flow for the project (and for each WBS element)?
- What is the
impact of overtime?
- What additional
resources are needed to meet the constraints of the project?
- How will a
change in the priority of a certain WBS element affect the total project?
The more sophisticated packages can provide answers to schedule
and cost based on:
- Adverse weather
conditions
- Weekend
activities
- Unleveled
manpower requirements
- Variable crew
size
- Splitting of
activities
- Assignment of
unused resources
Regardless of the sophistication of computer systems, printers
and plotters prefer to draw
straight lines rather than circles. Most software systems today
use precedence networks, as
shown in Figure 31.1 below, which attempt to show
interrelationships on bar charts. As shown
in the figure, task 1 and task 2 are related because of the
solid line between them. Task 3 and
task 4 can begin when task 2 is half finished. (This cannot be
shown easily on PERT without
splitting activities.) The dotted lines indicate slack. The
critical path can be identified either by
putting an asterisk (*) beside the critical elements, by making
the critical connections in a
different-colored ink, or by making the critical path a boldface
type.22
Precedence Network
The more sophisticated software packages display precedence
networks in the format shown in
Figure 31.2 below. In each of these figures, work is
accomplished during the activity. This is
sometimes referred to as the activity-on-node method. The arrow
represents the relationship or
constraint between activities.
Typical Precedence Relationships
Figure above 31.2 (A) illustrates a finish-to-start constraint.
In this figure, activity 2 can start no
earlier than the completion of activity 1. Figure 31.2 (B)
illustrates a start-to-start constraint.
Activity 2 cannot start prior to the start of activity 1. Figure
31.2 (C) illustrates a finish-to-finish
constraint. In this figure, activity 2 cannot finish until
activity 1 finishes. Lastly, Figure 31.2 (D)
illustrates a percent-complete constraint. In this figure, the
last 20 percent of activity 2 cannot
be started until 50 percent of activity 1 has been completed.
Computerized Information Flow
Figure 31.3 above shows the typical information that appears in
each of the activity boxes
shown in the previous figure. The box identified as
''responsibility cost center" could also have
been identified as the name, initials, or badge number of the
person responsible for this activity.
Figure 31.4 below shows the comparison of three of the different
network techniques.
Comparison of Networks
31.2 PRICING AND ESTIMATION:
As we know that with the complexities involved, it is not
surprising that many business
managers consider pricing an art. Having the right intelligence
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. Even more important,
intelligence sources are often unreliable. The only thing worse
than missing information, is
wrong or misleading information.
When it comes to competitive pricing, the old saying still
applies: "Those who talk don't know;
and those who know don't talk!" It is true, partially, that
pricing remains an art. However, a
disciplined approach certainly helps one to develop all the
input for a rational pricing
recommendation. A side benefit of using a disciplined management
process is that it leads to the
documentation of the many factors and assumptions involved at a
later point in time. These can
be compared and analyzed, contributing to the learning
experiences that make up the managerial
skills needed for effective business decisions.
Estimates are
not blind luck. They are
well-thought-out decisions based on 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:
- Mathematical
equations based on regression analysis
- Cost–quantity
relationships such as learning curves
- Cost–cost
relationships
- Cost–noncost
relationships based on physical characteristics, technical parameters, or performance characteristics
31.3 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.
Clearly, in each case, we have specific but different business
objectives. The objective for type I
acquisition is to win the program and execute it profitably and
satisfactorily according to
contractual agreements. The type II objective is often to win
the program and perform well,
thereby gaining a foothold in a new market segment or a new
customer community in place of
making a profit.
Accordingly, each acquisition type has its own, unique pricing
strategy, as summarized in Table
31.1 below.
Comparing the two pricing strategies for the two global
situations (as shown in Table below)
reveals a great deal of similarity for the first five points.
The fundamental difference is that for a
profitable new business acquisition the bid price is determined
according to actual cost, whereas
in a "must win" situation the price is determined by the market
forces. It should be emphasized
that one of the most crucial inputs in the pricing decision is
the cost estimate of the proposed
baseline. The design of this baseline to the minimum
requirements should be started early, in
accordance with well defined ground rules, cost models, and
established cost targets. Too often
the baseline design is performed in parallel with the proposal
development. At the proposal
stage it is too late to review and fine-tune the baseline for
minimum cost. Also, such a late start
does not allow much of an option for a final bid decision. Even
if the price appears outside the
competitive range, it makes little sense to terminate the
proposal development. As all the
resources have been sent anyway, one might just as well submit a
bid in spite of the remote
chance of winning.
Clearly, effective pricing begins a long time before proposal
development. It starts with
preliminary customer requirements, well-understood subtasks, and
a top-down estimate with
should-cost targets.
This allows the functional organization to design a baseline to
meet the customer requirements
and cost targets, and gives management the time to review and
redirect the design before the
proposal is submitted. Furthermore, it gives management an early
opportunity to assess the
chances of winning during the acquisition cycle, at a point in
time when additional resources
can be allocated or the acquisition effort can be terminated
before too many resources are
committed to a hopeless effort.
The final pricing review session should be an integration and
review of information already well
known in its basic context. The process and management tools
outlined here should help to
provide the framework and discipline for deriving pricing
decisions in an orderly and effective
way.
Two Global Pricing Strategies
31.4 TYPES OF ESTIMATES:
Note that 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.
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 (that is,
$/# of product or $/KW
electricity).
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, manhours,
dollars, materials, and so on.
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.
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.
Each company may have a unique approach to estimating. However,
for normal project
management practices, Table 31.2 below would suffice as a
starting point.
Standard Project Estimating
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. Table 31.3 below shows the
table of contents for a construction
estimating manual.
Estimating manuals, as the name implies, provide estimates. The
question, of course, is "How
good are the estimates?" Most estimating manuals provide
accuracy limitations by defining the
type of estimates (shown in Table 31.4 below). Using Table
below, we can create the next three
tables which illustrate the use of the estimating manual.
Not all companies can use estimating manuals. Estimating manuals
work best for repetitive
tasks or similar tasks that can use a previous estimate adjusted
by a degree-of-difficulty factor.
Activities such as Research and Development do not lend
themselves to the use of estimating
manuals other than for benchmark, repetitive laboratory tests.
Proposal managers must carefully consider whether the estimating
manual is a viable approach.
The literature abounds with examples of companies that have
spent millions trying to develop
estimating manuals for situations that just do not lend
themselves to the approach.227
Estimating Manual Table of Contents
During competitive bidding, it is important that the type of
estimate be consistent with the
customer's requirements. For in-house projects, the type of
estimate can vary over the life cycle
of a project:
• Conceptual
Stage:
Venture guidance or feasibility studies for the evaluation of
future work. This estimating is
often based on minimum-scope information.
• Planning
Stage:
Estimating for authorization of partial or full funds. These
estimates are based on
preliminary design and scope.
• Main Stage:
Estimating for detailed work.
• Termination
Stage:
Re-estimation for major scope changes or variances beyond the
authorization range.
Table 31.4:
Classes of Estimates
228
Table 31.5:
Checklist for Work Normally Required for the Various Classes of Estimates
31.5 PRICING PROCESS:
This activity schedules the development of the Work Breakdown
Structure (WBS) 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.
Note that the integration of the functional unit into the
project environment or system occurs
through the pricing-out of the work breakdown structure. The
total program costs obtained by
pricing out the activities over the scheduled period of
performance provide management with
the third tool necessary to successfully manage the project.
During the pricing activities, the
functional units have the option of consulting program
management about possible changes in
the activity schedules and work breakdown structure.
229
Table 31.6:
Data Required for Preparation of Estimates
The Work Breakdown Structure (WBS) and activity schedules are
priced out through the lowest
pricing units of the company. It is the responsibility of these
pricing units, whether they are
sections, departments, or divisions, to provide accurate and
meaningful cost data (based on
historical standards, if possible). All information is priced
out at the lowest level of performance
required, which, will be the task level. Costing information is
rolled up to the project level and
then one step further to the total program level.
Under ideal conditions, the work required (that is, man-hours)
to complete a given task can be
based on historical standards. Unfortunately, for many
industries, projects and programs are so
diversified that realistic comparison between previous
activities may not be possible. The
costing information obtained from each pricing unit, whether or
not it is based on historical
standards, should be regarded only as an estimate. How can a
company predict the salary
structure three years from now? What will be the cost of raw
materials two years from now?
Will the business base (and therefore overhead rates) change
over the duration of the program?
The final response to these questions shows that costing data
are explicitly related to an
environment that cannot be predicted with any high degree of
certainty. The systems approach
to management, however, provides for a more rapid response to
the environment than less
structured approaches permit.
Remember that once the cost data are assembled, they must be
analyzed for their potential
impact on the company resources of people, money, equipment, and
facilities. It is only through
a total program cost analysis that resource allocations can be
analyzed. The resource allocation
analysis is performed at all levels of management, ranging from
the section supervisor to the
vice president and general manager. For most programs, the chief
executive must approve final
cost data and the allocation of resources.
Proper analysis of the total program costs can provide
management (both program and
corporate) with a strategic planning model for integration of
the current program with other
programs in order to obtain a total corporate strategy.
Meaningful planning and pricing models
include analyses for monthly man-loading schedules per
department, monthly costs per
department, monthly and yearly total program costs, monthly
material expenditures, and total
program cash-flow and man-hour requirements per month.
231
Figure 31.5:
The Vertical Horizontal Interface
Previously we identified several of the problems that occur at
the nodes where the horizontal
hierarchy of program management interfaces with the vertical
hierarchy of functional
management.
The pricing-out of the work breakdown structure provides the
basis for effective and open
communication between functional and program management where
both parties have one common
goal. This is shown in Figure 31.5 above. After the pricing
effort is completed, and the program is
initiated, the work breakdown structure still forms the basis of
a communications tool by documenting
the performance agreed on in the pricing effort, as well as
establishing the criteria against which
performance costs will be measured. |