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Project Management

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LESSON 31
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.
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Figure 31.1: 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.
Figure 31.2: 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.
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Figure 31.3: 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.
Figure 31.4: 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
 Cost­quantity relationships such as learning curves
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Cost­cost relationships
Cost­noncost 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.
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Table 31.1: 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, man-
hours, 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
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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.
Table 31.2: 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.
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Table 31.3: 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
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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.
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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.
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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.
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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