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Project Management

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LESSON 32
PRICING AND ESTIMATION (CONTD.)
BROAD CONTENTS
Organizational Input Requirements
Labor Distributions
Overhead Costs
32.1
ORGANIZATIONAL INPUT REQUIREMENTS:
Note that once the work breakdown structure and activity schedules are established, the
program manager calls a meeting for all organizations that will be required to 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 positions of several
functional managers whose responsibilities may be similar to overlap on certain activities. An
example of this would be quality control activities. During the research and development phase
of a program, research personnel may be permitted to perform their own quality control efforts,
whereas during production activities the quality control department or division would have
overall responsibility. Unfortunately, one meeting is not always sufficient to clarify all
problems. Follow-up or status meetings are held, normally with only those parties concerned
with the problems that have arisen. Some companies prefer to have all members attend the
status meetings so that all personnel will be familiar with the total effort and the associated
problems. The advantage of not having all program-related personnel attend is that time is of the
essence when pricing out activities. Many functional divisions carry this policy one step further
by having a divisional representative together with possibly key department managers or section
supervisors as the only attendees at the kickoff meeting. The divisional representative then
assumes all responsibility for assuring that all costing data are submitted on time. This
arrangement may be beneficial in that the program office need contact only one individual in
the division to learn of the activity status, but it may become a bottleneck if the representative
fails to maintain proper communication between the functional units and the program office, or
if the individual simply is unfamiliar with the pricing requirements of the work breakdown
structure.
Time may be extremely important, during proposal activities. There are many situations in
which a Request for Proposal (RFP) requires that all responders submit their bids no later than a
specific date, say within thirty days. Under a proposal environment, the activities of the
program office, as well as those of the functional units, are under a schedule set forth by the
proposal manager. The proposal manager's schedule has very little, if any, flexibility and is
normally under tight time constraints so that the proposal may be typed, edited, and published
prior to the date of submittal. In this case, the Request for Proposal (RFP) will indirectly define
how much time the pricing units have to identify and justify labor costs.
The justification of the labor costs may take longer than the original cost estimates, especially if
historical standards are not available. Many proposals often require that comprehensive labor
justification be submitted. Other proposals, especially those that request an almost immediate
response, may permit vendors to submit labor justification at a later date.
Remember that in the final analysis, it is the responsibility of the lowest pricing unit supervisors
to maintain adequate standards, if possible, so that an almost immediate response can be given
to a pricing request from a program office.
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32.2
LABOR DISTRIBUTIONS:
The functional units supply their input to the program office in the form of man-hours as shown
in Figure 32.1 below.
Figure 32.1: Functional Pricing Flow
The input may be accompanied by labor justification, if required. The man-hours are submitted
for each task, assuming that the task is the lowest pricing element, and are time-phased per
month. The man-hours per month per task are converted to dollars after multiplication by the
appropriate labor rates. The labor rates are generally known with certainty over a twelve-month
period, but from then on are only estimates. How can a company predict salary structures five
years hence? If the company underestimates the salary structure, increased costs and decreased
profits will occur. If the salary structure is overestimated, the company may not be competitive;
if the project is government funded, then the salary structure becomes an item under contract
negotiations.
In this regard, the development of the labor rates to be used in the projection is based on
historical 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.
The labor hours submitted by the functional units are quite often overestimated for fear that
management will "massage" and reduce the labor hours while attempting to maintain the same
scope of effort. Many times management is forced to reduce man-hours either because of
insufficient funding or just to remain competitive in the environment. The reduction of man-
hours often causes heated discussions between the functional and program managers. Program
managers tend to think in terms of the best interests of the program, whereas functional
managers lean toward maintaining their present staff.
To cater to this, the most common solution to this conflict rests with the program manager. If
the program manager selects members for the program team who are knowledgeable in man-
hour standards for each of the departments, then an atmosphere of trust can develop between the
program office and the functional department so that man-hours can be reduced in a manner that
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represents the best interests of the company. This is one of the reasons why program team
members are often promoted from within the functional ranks.
The man-hours submitted by the functional units provide the basis for total program cost
analysis and program cost control. To illustrate this process, consider the following Example
32.1:
Example 32.1:
On May 15, Apex Manufacturing decided to enter into competitive bidding for the modification
and updating of an assembly line program. A work breakdown structure was developed as
shown below:
On June 1, each pricing unit was given the work breakdown structure together with the schedule
as shown in Figure 32.2 below. According to the schedule developed by the proposal manager
for this project, all labor data must be submitted to the program office for review no later than
June 15. It should be noted here that, in many companies, labor hours are submitted directly to
the pricing department for submittal into the base case computer run. In this case, the program
office would "massage" the labor hours only after the base case figures are available. This
procedure assumes that sufficient time exists for analysis and modification of the base case. If
the program office has sufficient personnel capable of critiquing the labor input prior to
submittal to the base case, then valuable time can be saved, especially if two or three days are
required to obtain computer output for the base case.
Figure 32.2: Activity Schedule for Assembly Line Updating
Note that during proposal activities, the proposal manager, pricing manager, and program
manager must all work together, although the program manager has the final say. The primary
responsibility of the proposal manager is to integrate the proposal activities into the operational
system so that the proposal will be submitted to the requestor on time. A typical schedule
developed by the proposal manager is shown in Figure 32.3 below. The schedule includes all
activities necessary to "get the proposal out of the house," with the first major step being the
submittal of man-hours by the pricing organizations. It also indicates the tracking of proposal
costs. The proposal activity schedule is usually accompanied by a time schedule with a detailed
estimates checklist if the complexity of the proposal warrants one.
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Figure 32.3: Proposal Activity Schedule
The checklist generally provides detailed explanations for the proposal activity schedule.
After the planning and pricing charts are approved by program team members and program
managers, they are entered into an Electronic Data Processing (EDP) system as shown in Figure
32.4 below. The computer then prices the hours on the planning charts using the applicable
department rates for preparation of the direct budget time plan and estimate-at-completion
reports. The direct budget time plan reports, once established, remain the same for the life of the
contract except for customer directed or approved changes or when contractor management
determines that a reduction in budget is advisable. However, if a budget is reduced by
management, it cannot be increased without customer approval.
Figure 32.4: Labor Planning Flow Chart
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In addition, the time plan is normally a monthly mechanical printout of all planned effort by
work package and organizational element over the life of the contract, and serves as the data
bank for preparing the status completion reports.
Initially, the estimate-at-completion report is identical to the budget report, but it changes
throughout the life of a program to reflect degradation, or improvement in performance, or any
other events that will change the program cost or schedule.
32.3
OVERHEAD RATES:
We should know that the ability to control program costs involves more than tracking labor
dollars and labor hours. Overhead dollars can be one of the biggest headaches in controlling
program costs and must be tracked along with labor hours and dollars. 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. For example, if overhead
rates apply only to the first forty hours of work, then, depending on the overhead rate, program
dollars can be saved by performing work on overtime where the increased salary is at a lower
burden. This can be seen in Example 32.2 below.
Example 32.2:
Assume that Apex Manufacturing 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?
On regular time the total cost is:
(500 hours) ($15.00/hour) (100% + 75% burden) = $13,125
On overtime, the total cost is:
(500 hours) ($15.00/hour 1.5 overtime) (100% + 5% burden) = $11,812.50
Therefore, the company can save $1,312.50 by performing the work on overtime. Scheduling
overtime can produce increased profits if the overtime overhead rate burden is much less than
the regular time burden. This difference can be very large in manufacturing divisions, where
overhead rates between 300 and 450 percent are common.
Regardless of whether one analyzes a project or a system, all costs must have associated
overhead rates. Unfortunately, many program managers and systems managers consider
overhead rates as a magic number pulled out of the air. The preparation and assignment of
overheads to each of the functional divisions is a science. Although the total dollar pool for
overhead rates is relatively constant, management retains the option of deciding how to
distribute the overhead among the functional divisions. A company that supports its Research
and Development staff through competitive bidding projects may wish to keep the Research and
Development overhead rate as low as possible. Care must be taken, however, that other
divisions do not absorb additional costs so that the company no longer remains competitive on
those manufactured products that may be its bread and butter.
Furthermore, the development of the overhead rates is a function of three separate elements:
direct labor rates, direct business base projections, and projection of overhead expenses. Direct
labor rates have already been discussed. The direct business base projection involves the
determination of the anticipated direct labor hours and dollars along with the necessary direct
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materials and other direct costs required to perform and complete the program efforts included
in the business base. Those items utilized in the business base projection include all contracted
programs as well as the proposed or anticipated efforts. The foundation for determination of the
business base required for each program can be one or more of the following:
Actual costs to date and estimates to completion
Proposal data
Marketing intelligence
Management goals
Past performance and trends
Additionally, the projection of the overhead expenses is made by an analysis of each of the
elements that constitute the overhead expense. A partial listing of those items that constitute
overhead expenses is shown in Table 32.1 below. Projection of expenses within the individual
elements is then made based on one or more of the following:
Historical direct/indirect labor ratios
Regression and correlation analysis
Manpower requirements and turnover rates
Changes in public laws
Anticipated changes in company benefits
Fixed costs in relation to capital asset requirements
Changes in business base
Bid and proposal (B&P) tri-service agreements
IR&D tri-service agreements
In case of many industries, such as aerospace and defense, the federal government funds a large
percentage of the Bid and proposal (B&P) and IR&D activities. This federal funding is a
necessity since many companies could not otherwise be competitive within the industry. The
federal government employs this technique to stimulate research and competition. Therefore,
Bid and proposal (B&P) and IR&D are included in the above list.
The annual budget is the prime factor in the control of overhead costs. This budget, which is the
result of goals and objectives established by the chief executive officer, is reviewed and
approved at all levels of management. It is established at department level, and the department
manager has direct responsibility for identifying and controlling costs against the approved
plan.
The departmental budgets are summarized, in detail, for higher levels of management. This
summarization permits management, at these higher organizational levels, to be aware of the
authorized indirect budget in their area of responsibility.
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Table 32.1: Elements of Overhead Rates
Monthly reports are published indicating current month and year-to-date budget, actuals, and
variances. These reports are published for each level of management, and an analysis is made
by the budget department through coordination and review with management. Each directorate's
total organization is then reviewed with the budget analyst who is assigned the overhead cost
responsibility. A joint meeting is held with the directors and the vice president and general
manager, at which time overhead performance is reviewed.
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Table of Contents:
  1. INTRODUCTION TO PROJECT MANAGEMENT:Broad Contents, Functions of Management
  2. CONCEPTS, DEFINITIONS AND NATURE OF PROJECTS:Why Projects are initiated?, Project Participants
  3. CONCEPTS OF PROJECT MANAGEMENT:THE PROJECT MANAGEMENT SYSTEM, Managerial Skills
  4. PROJECT MANAGEMENT METHODOLOGIES AND ORGANIZATIONAL STRUCTURES:Systems, Programs, and Projects
  5. PROJECT LIFE CYCLES:Conceptual Phase, Implementation Phase, Engineering Project
  6. THE PROJECT MANAGER:Team Building Skills, Conflict Resolution Skills, Organizing
  7. THE PROJECT MANAGER (CONTD.):Project Champions, Project Authority Breakdown
  8. PROJECT CONCEPTION AND PROJECT FEASIBILITY:Feasibility Analysis
  9. PROJECT FEASIBILITY (CONTD.):Scope of Feasibility Analysis, Project Impacts
  10. PROJECT FEASIBILITY (CONTD.):Operations and Production, Sales and Marketing
  11. PROJECT SELECTION:Modeling, The Operating Necessity, The Competitive Necessity
  12. PROJECT SELECTION (CONTD.):Payback Period, Internal Rate of Return (IRR)
  13. PROJECT PROPOSAL:Preparation for Future Proposal, Proposal Effort
  14. PROJECT PROPOSAL (CONTD.):Background on the Opportunity, Costs, Resources Required
  15. PROJECT PLANNING:Planning of Execution, Operations, Installation and Use
  16. PROJECT PLANNING (CONTD.):Outside Clients, Quality Control Planning
  17. PROJECT PLANNING (CONTD.):Elements of a Project Plan, Potential Problems
  18. PROJECT PLANNING (CONTD.):Sorting Out Project, Project Mission, Categories of Planning
  19. PROJECT PLANNING (CONTD.):Identifying Strategic Project Variables, Competitive Resources
  20. PROJECT PLANNING (CONTD.):Responsibilities of Key Players, Line manager will define
  21. PROJECT PLANNING (CONTD.):The Statement of Work (Sow)
  22. WORK BREAKDOWN STRUCTURE:Characteristics of Work Package
  23. WORK BREAKDOWN STRUCTURE:Why Do Plans Fail?
  24. SCHEDULES AND CHARTS:Master Production Scheduling, Program Plan
  25. TOTAL PROJECT PLANNING:Management Control, Project Fast-Tracking
  26. PROJECT SCOPE MANAGEMENT:Why is Scope Important?, Scope Management Plan
  27. PROJECT SCOPE MANAGEMENT:Project Scope Definition, Scope Change Control
  28. NETWORK SCHEDULING TECHNIQUES:Historical Evolution of Networks, Dummy Activities
  29. NETWORK SCHEDULING TECHNIQUES:Slack Time Calculation, Network Re-planning
  30. NETWORK SCHEDULING TECHNIQUES:Total PERT/CPM Planning, PERT/CPM Problem Areas
  31. PRICING AND ESTIMATION:GLOBAL PRICING STRATEGIES, TYPES OF ESTIMATES
  32. PRICING AND ESTIMATION (CONTD.):LABOR DISTRIBUTIONS, OVERHEAD RATES
  33. PRICING AND ESTIMATION (CONTD.):MATERIALS/SUPPORT COSTS, PRICING OUT THE WORK
  34. QUALITY IN PROJECT MANAGEMENT:Value-Based Perspective, Customer-Driven Quality
  35. QUALITY IN PROJECT MANAGEMENT (CONTD.):Total Quality Management
  36. PRINCIPLES OF TOTAL QUALITY:EMPOWERMENT, COST OF QUALITY
  37. CUSTOMER FOCUSED PROJECT MANAGEMENT:Threshold Attributes
  38. QUALITY IMPROVEMENT TOOLS:Data Tables, Identify the problem, Random method
  39. PROJECT EFFECTIVENESS THROUGH ENHANCED PRODUCTIVITY:Messages of Productivity, Productivity Improvement
  40. COST MANAGEMENT AND CONTROL IN PROJECTS:Project benefits, Understanding Control
  41. COST MANAGEMENT AND CONTROL IN PROJECTS:Variance, Depreciation
  42. PROJECT MANAGEMENT THROUGH LEADERSHIP:The Tasks of Leadership, The Job of a Leader
  43. COMMUNICATION IN THE PROJECT MANAGEMENT:Cost of Correspondence, CHANNEL
  44. PROJECT RISK MANAGEMENT:Components of Risk, Categories of Risk, Risk Planning
  45. PROJECT PROCUREMENT, CONTRACT MANAGEMENT, AND ETHICS IN PROJECT MANAGEMENT:Procurement Cycles