Appendix D -- Cost estimating checklist
This book is about pursuit, capture, and management of complex and/or high technology projects, in which the low bidder is not necessarily the winner. These projects are much more prone to cost and schedule overruns than other types of projects.
There appear to be two reasons for this: 1) the projects are inherently risky because of their subject matter and 2) the cost and schedule estimating efforts are too casual. By the latter we mean they either do not have sufficient rigor, or they have insufficient management controls, or both. Because they frequently are very important projects, cost and schedule estimating management is often impeded by political considerations that interfere with proper management controls.
While no checklist is guaranteed to withstand a full frontal assault by a pursuit team that already knows the answer it wants before it starts to estimate, the checklist here discussed does make an effort to do just that. If its conditions and strictures are strongly upheld by management, realistic estimates are likely to emerge.
For readers used to simply slapping on some percentage of direct cost provided by the accounting department and calling that an estimate of overhead costs, this checklist will surprise. It requires explicit consideration of the need for overhead resources, and an estimate of their costs. This estimate is compared to the percentage estimate normally made as a check of its deficiency or its surplus. It is also useful in risk analysis (see chapter 14).
This checklist may surprise in other ways as well. It calls for a degree of rigor in several areas that may not be customary to some readers. In particular, it calls for tight management of the supporting documentation and deep consideration of project risks and their potential for creating cost and schedule overruns.
All project cost estimates are essentially estimates of the underlying resources needed to perform the project, which are then converted to units of currency, e.g., dollars. Resources commonly used to complete a project include land, labor, material, services, equipment, buildings, infrastructure, and time. One reason for project overruns is that one or more of these resource needs is overlooked or misunderstood and its cost is totally or partially left out of the estimate, or is estimated inappropriately. As a prelude to forming the checklist, let’s briefly consider each one of these resources.
Land
“Land” is essentially space on our planet for which there are competing interests or uses. We may be at liberty to use a space on the Antarctic continent cost free, because nobody else wants to use it. The same may apply to vast regions of the ocean floor, or of the ocean itself. But if the land we contemplate using has some kind of prior claim of use or ownership, we may have to pay to use it. In some projects, the land used is provided by or its use is arranged by the customer, nominally free to the project performer. Nevertheless, there could be costs to the performer if use of the land must be scheduled at inconvenient times, or if there are other restrictions on use.
Generally, if the project contemplates any significant modification of the land belonging to others, such as mining it, or building a road across it, reshaping it, or planting trees or crops on it, there will be use costs of some kind. For some types of use, there could be taxes.
These days, a not infrequent restriction on the use of land is due to environmental considerations, such as preservation of wildlife habitat or special scenic beauty. Another type of restriction is when land is already environmentally damaged, and further use is limited or denied because of hazards, or to prevent additional damage.
Labor
The largest single cost in an advanced project is usually labor cost. Ordinarily, cost of labor is deemed to include wages and salaries, fringe benefits, and employer paid payroll taxes such as Social Security and unemployment or disability benefits or insurance.
In many organizations, labor is divided into direct and indirect. Direct labor is deemed to be labor that is directly involved with the product, while indirect labor is all other labor that supports the product. In and of itself, this bifurcation is not harmful. What can be harmful, at least from a cost estimating standpoint, is the accounting treatment typically applied to indirect labor. According to commonly applied accounting rules its costs, company-wide, are collected and applied to direct labor as a “burden” percentage. This practice frequently distorts the true cost of a project. We will have more to say about this later in this appendix.
Typically, project labor is grouped into certain skill codes, depending on intended use. When this done, an average labor rate may be determined for each skill code, and that average is applied to each individual person having that code working on the project. This practice too can introduce errors in an estimate if the project team is not “average” in its composition.
Most commonly, labor costs are expressed as dollars (or other currency units) per hour, although for certain situations units of time other than hours may be preferred.
Material
Material is any good purchased for use on the project. Two types are usually recognized: 1) expendables, and 2) material that becomes part of the product. The assigned cost virtually always includes the full purchase cost, and may also include freight, sales taxes, value added taxes, and various kinds of customs duties, handling, quality inspection, or inventory charges.
Expendables typically include items such as office supplies, cleaning supplies, lubricants, process chemicals, and supplies for minor repairs. Material that becomes part of the product may include raw material, finished products such as forgings or castings, or assemblies or components of various kinds, such as fasteners and electronic components or mechanisms. It may also include paint and other finishing material, and material to create shipping containers. Sometimes, purchased software is regarded as material.
Commonly, the entire cost of a subcontract will be regarded as a material cost, regardless of the amount of labor the supplier puts into it. Here there is need for caution, however, because in certain teaming arrangements, it may be desirable to consider a subcontractor’s labor to be part of your labor cost, especially if the subcontractor works on your premises. Similarly, while consultants are often classified as a service, some companies treat them as material costs, and others treat them as part of their own labor force.
Services
The dominant services cost in advanced contracts is usually travel, or items related to travel. Sometimes freight costs are treated as a service, and sometimes so are consultants. Miscellaneous items related to travel are frequently treated as a service, such as employee relocation costs, costs of medical examinations prior to hiring, going to a foreign country, and so forth. Foreign currency exchanges could be a service. So could legal fees, aircraft landing fees, ship’s harbor fees, import and export duties, etc.
Costs of utilities, such as electricity, natural gas, fuel oil, etc., are often regarded as a service. Maintenance costs of equipment, buildings, and infrastructure are also often regarded as a service.
Equipment
A distinction often made with regard to equipment is capital equipment versus non-capital equipment. The term “capital equipment” is generally reserved for equipment with a life of at least one year that is used to assist in producing or selling a product, or performing a service. It should also have a cost in excess of a stated amount, commonly $5,000, although this varies from firm to firm. This cost generally includes the purchase cost and all other costs of acquisition.
Non-capital equipment is every other kind of equipment.
Accountants generally depreciate capital equipment over a period of years, and immediately expense non-capital equipment.
Generally, expensed equipment is charged directly to a project. Capital equipment depreciation is often charged directly to a project for the period of time it is used by the project. Alternately, all capital equipment could be put into a pool, and allocated to individual projects in some manner.
Buildings
Generally, a building is any man-made structure intended for human occupation or as a work place or for storage. Like capital equipment, accountants typically depreciate the cost of a building over a period of years. The cost of the land supporting a building is not depreciated.
Generally, depreciation of a building is charged to a project for the part of the building and the period of time it is used by the project.
Infrastructure
Infrastructure is the physical systems and structures, other than buildings, needed for a project to perform its work. It includes roads, water supply, sewers, electrical power grids, telecommunications, and the like.
Generally, if infrastructure is built for the use of a project, the contract will specify ownership and disposition of it when the project ends. If a project makes use of existing infrastructure, there may be depreciation charges or other fees charged for that use.
Time
The simple passage of time generally creates charges to a project only if resources are being used which have costs that are based on the passage of time. Thus labor is generally charged, even if unproductive, if the people must be present and available but cannot work. Real estate rents and leases are also based on time. So are equipment rentals.
Sometimes project contracts contain penalty clauses such that payments to the performer are reduced if too much time is consumed. Alternately, there may be incentive payments if less than the planned time is used.
In some multi-year projects, the time value of money plays a role, as does the phenomenon of inflation. To the extent that either of these is important, estimators must account for them.
Project estimates must take all of these costs, or related cost affecting factors into account. Given competent estimating staff, they generally they do, but not always in a manner which minimizes projects costs, thus increasing win probability. For that reason, the checklist provided here contains some requirements that may at first seem unusual.