Pricing and Estimating
Approaches to pricing and estimating – costs, labour, overhead, and maerials
Pavel Adámek
Project management

Outline of the lecture
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•Types of estimates
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•Labour Distributions
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•Support Costs
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•Economic Project Selection Criteria – Capital Budgeting
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Introduction
•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:
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•Mathematical equations based on regression analysis
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•Cost–quantity relationships such as learning curves
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•Cost–cost relationships
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•Cost–noncost relationships based on physical characteristics, technical parameters, or performance
characteristics

Introduction
•Specific pricing strategies must be developed for each individual situation. Frequently, however,
one of two situations prevails when one is pursuing project acquisitions competitively.
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•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.
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•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.
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•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.

Understanding control
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•Comparing the two pricing strategies for the two global situations reveals a great deal of
similarity for the first five points.
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•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 force
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Two global pricing strategies
Source: Kerzner, H. Project Management

Types of estimates
•Projects can range from a feasibility study, through modification of existing facilities, to
complete design, procurement, and construction of a large complex.
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•Many companies try to standardize their estimating procedures by developing an estimating manual.
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•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.
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Types 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).
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•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.
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•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.
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Types of estimates
•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.
•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.
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–Planning stage: Estimating for authorization of partial or full funds. These estimates are based
on preliminary design and scope.
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Classes of estimates
Source: Kerzner, H. Project Management

Types of estimates
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Classes of estimates
Source: Kerzner, H. 2017.  Project Management
Checlist for work normály required for the various classes (I-VI)
Source: Kerzner, H. 2017.  Project Management

Types of estimates
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 systém or project. The
development of these two tools is normally the responsibility of the program office with input from
the functional units.
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•The integration of the functional unit into the project environment or system occurs through the
pricing-out of the work breakdown structure.
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•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.
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•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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Types of estimates
Pricing proces
•Once the cost data are assembled, they must be analyzed for their potential impact on the company
resources of people, money, equipment, and facilities.
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•It is only through a total program cost analysis that resource allocations can be analyzed.
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•The resource allocation analysis is performed at all levels of management, ranging from the
section supervisor to the vice president and general manager.
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•For most programs, the chief executive must approve final cost data and the allocation of
resources.
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Labour Distributions
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•The functional units supply their input to the program office in the form of man-hours.
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•The man-hours are submitted for each task, assuming that the task is the lowest pricing element,
and are time-phased per month.
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•The man-hours per month per task are converted to dollars after multiplication by the appropriate
labour rates.
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Labour Distributions
•The input may be accompanied by labour justification, if required.
•The labour 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?
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•If the company underestimates the salary structure, increased costs and decreased profits will
occur.
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•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.
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Labour Distributions
•The development of the labour 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.
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•Average hourly rates are determined for each labour unit by direct effort within the operations at
the department level.
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•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.
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•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.
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Labour Distributions
•Many times management is forced to reduce man-hours either because of insufficient funding or just
to remain competitive in the environment.
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•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.
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•The most common solution to this conflict rests with the program manager.
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•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 represents
the best interests of the company

Labour Distributions
•Each pricing unit was given the work breakdown structure together with the schedule.
•It should be noted here that, in many companies, labour 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 labour hours only after the base case figures are available.
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•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 labour 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.
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•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.
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•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.

Labour Distributions
•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.
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•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.
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Source: Kerzner, H. 2017.  Project Management
Labour planning flowchart

Support Costs
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•The salary structure, overhead structure, and labour hours fulfil three of four major pricing
input requirements.
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•The fourth major input is the cost for materials and support.
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•Six subtopics are included under materials/support: materials, purchased parts, subcontracts,
freight, travel, and other.
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•Freight and travel can be handled in one of two ways, both normally dependent on the size of the
program.

Support Costs
•Determination of the material costs is very time-consuming, more so than cost determination for
labour hours.
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•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.
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Source: Kerzner, H. 2017.  Project Management
Material planning flowchart

Support Costs
•Using logical pricing techniques will help in obtaining detailed estimates.
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•The following thirteen steps provide a logical sequence to help a company control its limited
resources.
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•These steps may vary from company to company.
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.
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.

Support Costs
The list below shows the typical pricing reports:
•A detailed cost breakdown for each 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.
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•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.
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•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.
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•A yearly cost distribution table. This table is broken down by WBS element and shows the yearly
(or quarterly) costs that will be required.
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Support Costs
The list below shows the typical pricing reports:
•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.
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•A monthly labour 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.
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•A raw material and expenditure forecast. This shows the cash flow for raw materials based on
vendor lead times, payment schedules, commitments, and termination liability.
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•Total program termination liability per month. This table shows the customer the monthly 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.

Economic Project Selection Criteria – Capital Budgeting
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•Project managers are often called upon to be active participants during the benefit-to-cost
analysis of project selection.
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•It is highly unlikely that companies will approve a project where the costs exceed the benefits.
Benefits can be measured in either financial or nonfinancial terms.
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•The process of identifying the financial benefits is called capital budgeting, which may be
defined as the decision-making process by which organizations evaluate projects that include the
purchase of major fixed assets such as buildings, machinery, and equipment.

Economic Project Selection Criteria – Capital Budgeting
Sophisticated capital budgeting techniques take into consideration depreciation schedules, tax
information, and cash flow.
Since only the principles of capital budgeting will be discussed in this text, we will restrict
ourselves to the following topics:
•Payback Period - The payback period is the exact length of time needed for a firm to recover its
initial investment as calculated from cash inflows.
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–Payback period is the least precise of all capital budgeting methods because the calculations are
in dollars and not adjusted for the time value of money.
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Economic Project Selection Criteria – Capital Budgeting
Discounted Cash Flow (DCF)
•A dollar today is worth more than a dollar a year from now.
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•The reason for this is because of the time value of money. To illustrate the time value of money,
let us look at the following equation:
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Economic Project Selection Criteria – Capital Budgeting
Net Present Value (NPV)
•The net present value (NPV) method is a sophisticated capital budgeting technique that equates the
discounted cash flows against the initial investment.
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•This indicates that the cash inflows discounted to the present will not recover the initial
investment. This, in fact, is a bad investment to consider. Previously, we stated that the cash
flow stream yielded a payback period of four years.
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The decision-making criteria using NPV are as follows:
•If the NPV is greater than or equal to zero dollars, accept the project.
•If the NPV is less than zero dollars, reject the project.
A positive value of NPV indicates that the firm will earn a return equal to or greater than its
cost of capital.
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Economic Project Selection Criteria – Capital Budgeting
Internal Rate of Return (IRR)
•The internal rate of return (IRR) is perhaps the most sophisticated capital budgeting technique
and also more difficult to calculate than NPV.
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•The internal rate of return is the discount rate where the present value of the cash inflows
exactly equals the initial investment. IRR is the discount rate when NPV = 0.
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•Formula:
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RECAP
•The ability to project, analyse, and control problem costs requires coordination of pricing
information and cooperation between the functional units and upper-level management. A typical
company policy for cost analysis and review.
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•Corporate management may be required to initiate or authorize activities, if corporate/company
Resources are or may be strained by the program, if capital expenditures are required for new
facilities or equipment, or simply if corporate approval is required for all projects in excess of
a certain dollar amount.
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•The newly appointed program manager then selects this program’s team. Team members, who are also
members of the program office, may come from other programs, in which case the program manager may
have to negotiate with other program managers and upperlevel management to obtain these
individuals.

RECAP
•The system approach to determining total program costs.
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•This procedure normally creates a synergistic environment, provides open channels of communication
between all levels of management, and ensures agreement among all individuals as to program costs.

RECAP
•For most projects, both IRR and NPV will generate the same accept-reject decision.
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•However, there are differences that can exist in the underlying assumptions that can cause the
projects to be ranked differently.
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•The major problem is the differences in the magnitude and timing of the cash inflows. NPV assumes
that the cash inflows are reinvested at the cost of capital, whereas IRR assumes reinvestment at
the project’s IRR. NPV tends to be a more conservative approach.
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•The timing of the cash flows is also important. Early year cash inflows tend to be at a lower cost
of capital and are more predictable than later year cash inflows. Because of the downstream
uncertainty, companies prefer larger cash inflows in the early years rather than the later years.
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