BENCHMARKING YOUR BUSINESS: The Science of Cost Estimating

Your company deserves the most accurate pricing system available. The economic uncertainty that your company is facing demands that you have a system that will not only allow you to price your work accurately, but also allow you to benchmark your pricing as well as your competitors. Companies that price their work accurately and consistently will outperform their competition, even in tough economic times.    

The primary goal of cost estimating is to determine your costs for a project. Direct cost, such as materials, field labor and equipment, are easy to calculate and include in your pricing. General and administrative (G&A) overhead costs – the indirect costs – cause the most confusion.
 
This is also the primary area where the six methods of cost estimating differ. Factoring, the single overhead recovery system (SORS), the dual overhead recovery system (DORS) and the multiple overhead recovery system (MORS) all use percentages multiplied by one or more direct cost elements to calculate and allocate G&A overhead to jobs being priced. The fifth method, market-driven unit pricing, simply has you pluck common unit prices from the market.
 
Upon reviewing the pricing scenarios for these methods, we can draw two conclusions. First, calculating G&A overhead costs to allocate and put into a price by means of multiplying one or more direct costs by percentages is an automatic mathematical mistake – a false mathematical assumption.
 
Second, there is no correlation between the amount of gross profit margin (GPM), G&A overhead plus net profit margin, you desire to see on your financial statement at year’s end and the amount of GPM that you should put on an individual job being priced. Calculating and allocating G&A overhead to your pricing creates inconsistencies and inaccuracies. As a result, you will under price some jobs while overpricing others. And in a competitive market, guess which ones your company will win? The ones you under price.
 
This is why I use the G&A overhead per hour method to calculate and allocate G&A costs to my pricing. Of the six methods, it is the most accurate and consistent. Its merits can be proven and demonstrated scientifically quite readily. It is also the simplest of the six for calculating accurate costs.
 
Cost estimating and benchmarking are both sciences. As such, the merits or demerits of a cost estimating system must be open to scientific verification. Five of the six estimating methods do not pass the test.

Jim Huston is president of J.R. Huston Enterprises, a Denver-based green industry consulting firm. Reach him at 800/451-5588, benchmarking@gie.net or www.jrhuston.biz.