1. CS-411W VIII – Budgeting, Costing, and Pricing

2. Definitions Cost - the value of inputs that have been used to produce something. Inputs are typically investment dollars, labor costs, materials costs, subcontract costs, overhead expenses etc. Price - the amount of payment or compensation established for a good, service or asset. Profit – the difference between Price and Cost Loss – occurs when Cost is greater than Price

3. Definitions (cont) PriceCost Profit Operating at a Profit PriceCost Profit (Loss) Operating at a Loss

4. Definitions (cont) Cost Estimate - an assessment, approximation, or estimate of the investment of labor, materials, and overhead expenses required to complete a project or task. –Based on analysis and judgment –Result of a formal or an informal process –May employ metrics/historical data (lines of code per man day etc.)

5. Definitions (cont) Budget –the process of combining the estimated costs of individual activities or work packages to establish a baseline profile of project costs over time –Also provides a plan for obtaining resources and tracking costs throughout the project life-cycle –Requires having all cost estimating processes completed –Most common methods: Top Down, Bottom Up, Iterative

6. Definitions (cont) Cost Management – the processes required to ensure that a project team completes a project within approved budget. Successful cost management requires: –Well-defined project scope –Accurate cost estimates –Realistic budget

7. Estimating Costs Elements of Cost –Labor –Materials –External Resources Subcontractors Consultants, etc. –Overhead Expenses Facilities/Utilities Benefits Taxes Management Costs Financing

8. Estimating Costs Factors Affecting Cost –Specification of Scope and/or Requirements: more detail allows better cost estimating Detailed requirements provides for better task breakdown Less contingency required for uncertainty –Experience of Project Team Highly experienced teams typically more efficient in achieving project objectives Highly experienced team members typically more expensive (per labor hour) Balance of experience and labor cost must be achieved

9. Estimating Costs Factors Affecting Cost (cont) –Project Schedule Highly compact schedule requires on-demand availability of resources, experienced team and short lead time on materials and equipment Long, disjointed schedule injects dead-time, allows for loss of momentum and focus and inefficient use of resources Realistic schedule based on team experience and availability of resources most cost effective

10. Estimating Costs Factors Affecting Cost (cont) –External Factors Availability of specialty equipment, materials, or experience Economic factors - such as lending rates, currency exchange rates when dealing with “offshore” partners and vendors World affairs – such as increased fuel costs affecting travel and shipping rates, high demand for unique personnel experience or products critical to completion of the project –Simple example: building materials costs skyrocketed after Katrina. Projects dependent on availability of materials at a market price that pre-dated Katrina suffered significant adverse cost impact (I.e. less profit – or more loss)

11. Estimating Costs Types of Cost Estimates –Rough Order of Magnitude (ROM) –Budgetary –Definitive

12. Estimating Costs Rough Order of Magnitude (ROM) –Typically a best-estimate based on similar (prior) efforts, experience, and various assumptions –Should be “high” to provide for downward adjustment as more detail is available –Provided purely for planning purposes to establish an initial framework or upper boundary for estimated costs

13. Estimating Costs Budgetary Estimate –Provided when more detail is available regarding project scope, schedule, etc. –Established based on preliminary cost estimates and anticipated project schedule –Typically accurate to within 25% of final budget

14. Estimating Costs Definitive Estimate –Final assessment based on all available information –Addresses scope, resource availability, external costs (materials, subcontracors, other factors), and schedule –Includes appropriate contingencies for scope, schedule, and other risk uncertainties

15. Budget Preparation Methods: –Top-down: Budgets for top level tasks established first – then broken down to lower-level task allocations –Bottom-up: Budgets for lowest-level tasks established first – then rolled up to establish upper-level budgets –Iterative: Budgets are established at each level by responsible person(s) assigned. Upper-level budgets are established as an outcome of a negotiation between upper and lower-level estimates

16. Top Down Budgeting –Process High-level budget made first High-level budget used to dictate low level budgets –Advantages Provides high degree of control for experienced managers Helps address overlap between tasks –Disadvantages Lower-level tasks may be under-funded Individuals responsible for lower level tasks may not have a sense of ownership for the budget Budget Preparation

17. Bottom Up Budgeting –Process Budgets established at lower-levels first Lower-level budgets combined to establish upper-level budgets –Advantages High degree of accuracy for individual tasks Individuals responsible for low-level tasks “own” the budgets (i.e. they developed them). –Disadvantages More tendency towards duplication where tasks partially overlap (I.e. each task treated in isolation) Roll-up of lower-level budgets to overall budget frequently exceeds overall budget constraints (due to duplication in estimates and inflated low-level estimates).

18. Budget Preparation Iterative Budgeting –Process Obtain budget estimates at each level Negotiate between upper and lower-levels to agree on a final budget –Advantages Establishes ownership of budgets at all levels Provides good mechanism for identifying tradeoffs necessary to meet budgeting goals and disseminating ideas throughout the project team –Disadvantages Time-consuming process typically required to negotiate budgets between levels Final Budget Estimated Budget

19. Profile of Top-Level Tasks as proportion of Overall Budget

20. Relationship Between Cost Estimate and Budget

21. Pricing Concepts Revisited: Cost is the total of all expenses associated with completing a project Price is the total amount of compensation received for completion of a project or sale of a product Profit is the difference between Cost and Price PriceCost Profit

22. Pricing Factors Affecting Price and Profitability –Competitive Environment: More competition drives Price down –Degree of Specialization: Requirement for highly specialized skill set, experience, or equipment reduces competitive field and typically drives price up –Risk and/or Uncertainty: Degree of risk or uncertainty associated with technical, schedule, or performance aspects increases cost or profit contingencies associated with risk and increase price