Pricing and Estimating

B.Sravanthi
CED, KITSW
Introduction:
A disciplined approach helps in developing 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 time.
These can be compared and analyzed, contributing to
the learning experiences that make up the managerial
skills needed for effective business decisions
Cont..
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
GLOBAL PRICING STRATEGIES
Two types:
Type I:one-of-a-kind program with little or no follow-on
potential
Type II: 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
TWO GLOBAL PRICING STRATEGIES
Cont..
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 when additional resources can be allocated or the
acquisition effort can be terminated before too many
resources are committed to a hopeless effort.
Cont..
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.
TYPES OF ESTIMATES
Good estimating requires that information be
collected prior to the initiation of the estimating
process.
● Recent experience in similar work
● Professional and reference material
● Market and industry surveys
● Knowledge of the operations and processes
● Estimating software and databases if available
● Interviews with subject matter experts
Cont..
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.
 Cont..
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
 Order-of-magnitude estimates are top-down estimates usually
applied to level 1 of the WBS, and in some industries, use of
parametric estimates are included. A parametric estimate is
based upon statistical data. For example, assume that you live
in a Chicago suburb and wish to build the home of your dreams.
You contact a construction contractor who informs you that the
parametric or statistical cost for a home in this suburb is $120
per square foot. In Los Angeles, the cost may be $4150 per
square foot.
 Cont..
Approximate 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.
Cont..
Definitive estimate
 It 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
learning curves:
 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.
Cont..
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.
Standard project estimating
Cont..
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.
PRICING OUT THE WORK:
Using logical pricing techniques will help in obtaining detailed estimates.
The following 13 steps provide a logical sequence to help a company
control its limited resources. These steps may vary from company to
company.
1: Provide a complete definition of the work requirements.
2: Establish a logic network with checkpoints.
3: Develop the work breakdown structure.
4: Price out the work breakdown structure.
5: Review WBS costs with each functional manager.
6: Decide on the basic course of action.
7: Establish reasonable costs for each WBS element.
8: Review the base case costs with upper-level management.
9: Negotiate with functional managers for qualified personnel.
10: Develop the linear responsibility chart.
11: Develop the final detailed and PERT/CPM schedules.
12: Establish pricing cost summary reports.
13: Document the result in a program plan.
Typical pricing reports:
A detailed cost breakdown for each WBS element
A total program manpower curve for each
department
A monthly equivalent manpower cost summary
A yearly cost distribution tabl.
A functional cost and hour summary
A monthly labor hour and dollar expenditure
forecast
A raw material and expenditure forecast
Total program termination liability per month
Pricing review procedure:
 ESTIMATING HIGH-RISK PROJECTS

Whether a project is high-risk or low-risk

depends on the validity of the historical estimate.
Construction companies have well-defined
historical standards, which lowers their risk,
whereas many R&D and MIS projects are high
risk.
A common technique used to estimate high-risk
projects is the “rolling wave” or “moving window”
approach.
Cont..
LIFE-CYCLE COSTING (LCC)
industrial firms are adopting the life-cycle costing
approach that has been developed and used by
military organizations. Simply stated, LCC
requires that decisions made during the R&D
process be evaluated against the total life-cycle
cost of the system.
Life-cycle costs are the total cost to the
organization for the ownership and acquisition of
the product over its full life. This includes the cost
of R&D, production, operation, support, and,
where applicable, disposal. x
Cont..
A typical breakdown description might include:
R&D costs
Production cost
Construction cost
Operation and maintenance cost
Product retirement and phase out cost
 Cont..
Life-cycle cost analysis is the systematic analytical
process of evaluating various alternative courses of
action early on in a project, with the objective of
choosing the best way to employ scarce resources. Life-
cycle cost is employed in the evaluation of alternative
design configurations, alternative manufacturing
methods, alternative support schemes, and so on. This
process includes:
● Defining the problem (what information is needed)
● Defining the requirements of the cost model being used
● Collecting historical data–cost relationships
● Developing estimate and test results
Cont..
Successful application of LCC will:
● Provide downstream resource impact visibility
● Provide life-cycle cost management
● Influence R&D decision-making
● Support downstream strategic budgeting
 Cont..
limitations to life-cycle cost analyses
The assumption that the product, as known, has
a finite life-cycle
A high cost to perform, which may not be
appropriate for low-cost/low-volume production
A high sensitivity to changing requirements