Working with numerous prospects and clients over the years, we often find it helpful to clarify the difference between estimating the cost of performing the work scope in an RFP and pricing that cost estimate.
Cost estimating and pricing are two sides of the same coin. You need the foundation of a data driven cost estimate to execute the RFP scope of work so you have a credible basis to determine your pricing strategy to win the contract. Without a sound cost estimate for the work scope, the pricing strategy gets lost because it isn’t built on a realistic assessment to perform the work.
Definitions – Cost Estimating
Cost estimating is the process of developing the approximate cost of completing a defined scope of work, a quantitative result the proposal team cost estimating professionals can substantiate. Creating a realistic cost estimate and documenting the basis of estimate rationale is often the more difficult part of preparing a proposal response – getting this right makes it easier to determine your best pricing strategy.
A credible project cost estimate requires:
- A clear definition of the scope of work, technical requirements, performance characteristics, deliverables, schedule and cost constraints, dependencies, and assumptions. If your proposal team doesn’t have a good understanding of the scope of work, it is difficult to define the tasks, sequence of work, task durations, and resource requirements to meet the customer’s objectives.
- Identifying, assessing risks and opportunities. Without a clear definition of the work scope, it is difficult to identify let alone assess the risks and opportunities in the work scope or how you intend to perform the work. Assessing likely risks can help the proposal team develop the necessary time, cost, or other allowances to reduce risks to an acceptable level. Identifying opportunities can also help the proposal team identify areas that could support the pricing strategy – perhaps proposing a more reliable process, different resources, or other work techniques that could save the customer time and money. These risk and opportunity assessments should be captured in their basis of estimate narratives.
- Availability of verifiable source data that can be traced to your business systems. Your proposal teams should be able to search and locate reliable historical and actual cost source data they can use for their BOE and related narrative discussion.
- Selecting an appropriate cost estimating methodology for the elements of work. This was discussed in another blog, How to Develop a Basis of Estimate for Government Contracts. The objective is use to methods where it is possible to substantiate how the BOE was developed with facts and figures. The narrative discussion should be clear and concise so anyone can follow how the cost estimate was developed and determined. If someone else can’t figure out how the proposal team arrived at their cost estimate, the business development team won’t know what factors they can adjust to meet their pricing objectives.
- Top down and bottom up traceability. Using a central database to develop the cost estimate makes this easier to achieve when proposal team members are using a standard structure to develop their complete set of cost estimates and enter basis of estimate narrative text. Bi-directional integration with a schedule tool also helps the proposal team ensure the resource loaded schedule activities align with the cost estimate work packages and time phased resource requirements. Without reliable source data, it is difficult at best for the business development team to do their what-if analysis for their pricing strategy.
Definitions – Pricing
Pricing is the process of determining the amount of money your company will charge the customer to deliver the product or services as specified in the RFP. There are a number of factors the business development team considers such as sales volume, how you intend to deliver the product or service, competitors, value of the product to the customer, and market place positioning.
Once the business development team is able to assess the cost estimate (the output from the proposal team’s development process), they can analyze different factors to determine their pricing strategy to meet their business objectives. Examples of common factors include:
- Overhead rates. These are often driven by sales volume and other corporate factors. When a company has an established Cost Accounting Standards Disclosure Statement as well as approved forward pricing rates in place with the government, these are often fixed and are only adjusted on an agreed upon schedule. There may not be much opportunity to adjust these for a given proposal.
- Labor resource requirements. Perhaps the skill mix, duration, or sequence of work can be adjusted to reduce the number of labor hours or direct cost. What’s the schedule impact of making these changes? Would it make sense to outsource some of the work effort? If they do that, are there other risk factors that must be considered? What about the location of where the work is performed? Perhaps labor overhead rates would be lower should a different corporate facility perform the work.
- Material requirements. Is it better or less expensive to make or buy a part? Do you need to get more quotes from different suppliers? It is possible to substitute parts? Are there any quantity discounts?
- Risks and opportunities. What is the level of uncertainty management is willing to accept? This is often dependent on the scope of work and whether the company is working to get into a new market or delivering products they have produced for years.
- Overall business strategy. It could be the company is willing to lose money on a contract under the assumption they will make money on follow-on contracts or a long-term sustainment contract. This requires a good understanding of what’s important to the customer, work scope, risk factors, contract type, and how the evaluation criteria may be weighted.
Putting All the Proposal Cost Volume Pieces Together
The proposal and business development team work through the iterative process of making adjustments to the base cost estimate data, rationale, and assumptions to arrive at the final cost estimate for submission to the customer. With a data driven cost estimate, it is easier for the business development team to assess their options using facts and figures. They have a credible basis to estimate the likely profit margin and are aware of potential risks, that if realized, could negatively impact the company’s bottom line. Based on the confidence level for winning the work and when the contract is likely to be awarded, corporate can also use the cost estimate data to manage key resource demand and availability.
Benefits of an Integrated Cost Estimating and Pricing Tool
This is where basis of estimate software such as ProjStream’s BOEMax can make a difference because it is an integrated cost estimating and pricing tool. It functions as “command central” for the proposal and business development team because the complete set of data for the cost estimate resides in a single database – including the narrative information.
With BOEMax, the cost estimators can quickly build out their data using the framework of the work breakdown structure, search previous cost estimates or historical actual cost data for use in their proposal, use established process standards as the basis for common tasks, create hierarchical project BOMs and document supplier BOEs. They can share schedule activity data bi-directionally with Oracle Primavera P6 or Microsoft Project to define their work packages, resource requirements, and create the time phased cost estimate data in BOEMax. The project’s rate structure automatically calculates labor direct costs and overhead costs. As they are developing their cost estimates, they can enter their basis of estimate narrative text or supporting data to describe how they arrived at their numbers.
Working with the business development team, the proposal team can use the global update functions to switch out resources, increase or decrease labor hours for a select set of tasks or resources, or make other adjustments to fine tune the source data. Should the sequence of work change, the proposal team can quickly make that adjustment using the bi-directional schedule integration to modify work package time frames, durations, resource requirements, and time phasing in BOEMax. The business development team can create multiple versions to compare their different pricing scenarios to determine their best options.
Because everything is in a single database, all outputs are fully traceable from the top down or bottom up. The proposal team can produce the final cost summary report for the cost volume submission to the customer with full confidence they have the complete set of data including basis of estimate narrative information so the customer can verify how they arrived at their numbers.
Don’t settle for bidding tools that just focus on pricing the cost estimate data. You are missing the most valuable piece of the puzzle to make fact-based pricing decisions – how did the proposal team arrive at their cost estimate numbers? If you can’t figure out the basis for the estimate, how do you know if you are making the right decisions on the pricing side? You do have options – schedule a demo of BOEMax today!
Updated September 25, 2020