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PRICING AND ESTIMATION (CONTD.)
BROAD CONTENTS
Organizational Input Requirements
Labor Distributions
Overhead Costs
32.1 ORGANIZATIONAL INPUT REQUIREMENTS:
Note that once the work breakdown structure and activity
schedules are established, the
program manager calls a meeting for all organizations that will
be required to submit pricing
information. It is imperative that all pricing or labor-costing
representatives be present for the
first meeting. During this ''kickoff" meeting, the work
breakdown structure is described in depth
so that each pricing unit manager will know exactly what his
responsibilities are during the
program. The kickoff meeting also resolves the
struggle-for-power positions of several
functional managers whose responsibilities may be similar to
overlap on certain activities. An
example of this would be quality control activities. During the
research and development phase
of a program, research personnel may be permitted to perform
their own quality control efforts,
whereas during production activities the quality control
department or division would have
overall responsibility. Unfortunately, one meeting is not always
sufficient to clarify all
problems. Follow-up or status meetings are held, normally with
only those parties concerned
with the problems that have arisen. Some companies prefer to
have all members attend the
status meetings so that all personnel will be familiar with the
total effort and the associated
problems. The advantage of not having all program-related
personnel attend is that time is of the
essence when pricing out activities. Many functional divisions
carry this policy one step further
by having a divisional representative together with possibly key
department managers or section
supervisors as the only attendees at the kickoff meeting. The
divisional representative then
assumes all responsibility for assuring that all costing data
are submitted on time. This
arrangement may be beneficial in that the program office need
contact only one individual in
the division to learn of the activity status, but it may become
a bottleneck if the representative
fails to maintain proper communication between the functional
units and the program office, or
if the individual simply is unfamiliar with the pricing
requirements of the work breakdown
structure.
Time may be extremely important, during proposal activities.
There are many situations in
which a Request for Proposal (RFP) requires that all responders
submit their bids no later than a
specific date, say within thirty days. Under a proposal
environment, the activities of the
program office, as well as those of the functional units, are
under a schedule set forth by the
proposal manager. The proposal manager's schedule has very
little, if any, flexibility and is
normally under tight time constraints so that the proposal may
be typed, edited, and published
prior to the date of submittal. In this case, the Request for
Proposal (RFP) will indirectly define
how much time the pricing units have to identify and justify
labor costs.
The justification of the labor costs may take longer than the
original cost estimates, especially if
historical standards are not available. Many proposals often
require that comprehensive labor
justification be submitted. Other proposals, especially those
that request an almost immediate
response, may permit vendors to submit labor justification at a
later date.
Remember that in the final analysis, it is the responsibility of
the lowest pricing unit supervisors
to maintain adequate standards, if possible, so that an almost
immediate response can be given
to a pricing request from a program office.
32.2 LABOR DISTRIBUTIONS:
The functional units supply their input to the program office in
the form of man-hours as shown
in below.
Functional Pricing Flow
The input may be accompanied by labor justification, if
required. The man-hours are submitted
for each task, assuming that the task is the lowest pricing
element, and are time-phased per
month. The man-hours per month per task are converted to dollars
after multiplication by the
appropriate labor rates. The labor 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? If the company underestimates the salary structure,
increased costs and decreased
profits will occur. 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.
In this regard, the development of the labor 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. Average
hourly rates are determined for each labor unit by direct effort
within the operations at the
department level. 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. 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. If the company has a
predominant aerospace or defense industry business base, then
these salaries are negotiated with
local government agencies prior to submittal for proposals.
The labor hours submitted by the functional units are quite
often overestimated for fear that
management will "massage" and reduce the labor hours while
attempting to maintain the same
scope of effort. Many times management is forced to reduce
man-hours either because of
insufficient funding or just to remain competitive in the
environment. The reduction of manhours
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.
To cater to this, the most common solution to this conflict
rests with the program manager. If
the program manager selects members for the program team who are
knowledgeable in manhour
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
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represents the best interests of the company. This is one of the
reasons why program team
members are often promoted from within the functional ranks.
The man-hours submitted by the functional units provide the
basis for total program cost
analysis and program cost control. To illustrate this process,
consider the following Example
32.1:
Example 32.1:
On May 15, Apex Manufacturing decided to enter into competitive
bidding for the modification
and updating of an assembly line program. A work breakdown
structure was developed as
shown below:
On June 1, each pricing unit was given the work breakdown
structure together with the schedule
as shown in Figure 32.2 below. According to the schedule
developed by the proposal manager
for this project, all labor data must be submitted to the
program office for review no later than
June 15. It should be noted here that, in many companies, labor
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 labor hours only after the base case
figures are available. 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 labor 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.
Activity Schedule for Assembly Line Updating
Note that 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. A typical schedule
developed by the proposal manager is shown in Figure 32.3 below.
The schedule includes all
activities necessary to "get the proposal out of the house,"
with the first major step being the
submittal of man-hours by the pricing organizations. It also
indicates the tracking of proposal
costs. The proposal activity schedule is usually accompanied by
a time schedule with a detailed
estimates checklist if the complexity of the proposal warrants
one.
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Proposal Activity Schedule
The checklist generally provides detailed explanations for the
proposal activity schedule.
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 as shown in Figure
32.4 below. The computer then prices the hours on the planning
charts using the applicable
department rates for preparation of the direct budget time plan
and estimate-at-completion
reports. The direct budget time plan reports, once established,
remain the same for the life of the
contract except for customer directed or approved changes or
when contractor management
determines that a reduction in budget is advisable. However, if
a budget is reduced by
management, it cannot be increased without customer approval.
Labor Planning Flow Chart
In addition, 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.
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.
32.3 OVERHEAD RATES:
We should know that the ability to control program costs
involves more than tracking labor
dollars and labor hours. Overhead dollars can be one of the
biggest headaches in controlling
program costs and must be tracked along with labor hours and
dollars. Although most programs
have an assistant program manager for cost whose
responsibilities include monthly overhead
rate analysis, the program manager can drastically increase the
success of his program by
insisting that each program team member understand overhead
rates. For example, if overhead
rates apply only to the first forty hours of work, then,
depending on the overhead rate, program
dollars can be saved by performing work on overtime where the
increased salary is at a lower
burden. This can be seen in Example 32.2 below.
Example 32.2:
Assume that Apex Manufacturing must write an interim report for
task 1 of project 1 during
regular shift or on overtime. The project will require 500
man-hours at $15.00 per hour. The
overhead burden is 75 percent on regular shift but only 5
percent on overtime. Overtime,
however, is paid at a rate of time and a half.
Assuming that the report can be written on either time, which is
cost-effective— regular time or
overtime?
• On regular time
the total cost is:
(500 hours) × ($15.00/hour) × (100% + 75% burden) = $13,125
• On overtime,
the total cost is:
(500 hours) × ($15.00/hour × 1.5 overtime) × (100% + 5% burden)
= $11,812.50
Therefore, the company can save $1,312.50 by performing the work
on overtime. Scheduling
overtime can produce increased profits if the overtime overhead
rate burden is much less than
the regular time burden. This difference can be very large in
manufacturing divisions, where
overhead rates between 300 and 450 percent are common.
Regardless of whether one analyzes a project or a system, all
costs must have associated
overhead rates. Unfortunately, many program managers and systems
managers consider
overhead rates as a magic number pulled out of the air. The
preparation and assignment of
overheads to each of the functional divisions is a science.
Although the total dollar pool
for
overhead rates is relatively constant, management retains the
option of deciding how to
distribute the overhead among the functional divisions. A
company that supports its Research
and Development staff through competitive bidding projects may
wish to keep the Research and
Development overhead rate as low as possible. Care must be
taken, however, that other
divisions do not absorb additional costs so that the company no
longer remains competitive on
those manufactured products that may be its bread and butter.
Furthermore, the development of the overhead rates is a function
of three separate elements:
direct labor rates, direct business base projections, and
projection of overhead expenses. Direct
labor rates have already been discussed. The direct business
base projection involves the
determination of the anticipated direct labor hours and dollars
along with the necessary direct
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materials and other direct costs required to perform and
complete the program efforts included
in the business base. Those items utilized in the business base
projection include all contracted
programs as well as the proposed or anticipated efforts. The
foundation for determination of the
business base required for each program can be one or more of
the following:
- Actual costs to
date and estimates to completion
- Proposal data
- Marketing
intelligence
- Management
goals
- Past
performance and trends
Additionally, the projection of the overhead expenses is made by
an analysis of each of the
elements that constitute the overhead expense. A partial listing
of those items that constitute
overhead expenses is shown in Table 32.1 below. Projection of
expenses within the individual
elements is then made based on one or more of the following:
- Historical
direct/indirect labor ratios
- Regression and
correlation analysis
- Manpower
requirements and turnover rates
- Changes in
public laws
- Anticipated
changes in company benefits
- Fixed costs in
relation to capital asset requirements
- Changes in
business base
- Bid and
proposal (B&P) tri-service agreements
- IR&D
tri-service agreements
In case of many industries, such as aerospace and defense, the
federal government funds a large
percentage of the Bid and proposal (B&P) and IR&D activities.
This federal funding is a
necessity since many companies could not otherwise be
competitive within the industry. The
federal government employs this technique to stimulate research
and competition. Therefore,
Bid and proposal (B&P) and IR&D are included in the above list.
The annual budget is the prime factor in the control of overhead
costs. This budget, which is the
result of goals and objectives established by the chief
executive officer, is reviewed and
approved at all levels of management. It is established at
department level, and the department
manager has direct responsibility for identifying and
controlling costs against the approved
plan.
The departmental budgets are summarized, in detail, for higher
levels of management. This
summarization permits management, at these higher organizational
levels, to be aware of the
authorized indirect budget in their area of responsibility.
Elements of Overhead Rates
Monthly reports are published indicating current month and
year-to-date budget, actuals, and
variances. These reports are published for each level of
management, and an analysis is made
by the budget department through coordination and review with
management. Each directorate's
total organization is then reviewed with the budget analyst who
is assigned the overhead cost
responsibility. A joint meeting is held with the directors and
the vice president and general
manager, at which time overhead performance is reviewed. |