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Cost Estimation and Pricing in
                                           Professional Services Delivery

                                   An introduction to a big picture representation of
                                   calculating the cost to serve and identifying three
                                                      price points




John Phillips - au.linkedin.com/in/johnphillips11kps/
Worthy but boring title? Is it worth me looking
            through this presentation?
            There is a wealth of research, data and special interest groups on
            pricing strategies and approaches related to products.
            For example, industries such as Fast Moving Consumer
            Goods, Consumer Electronics, Automotive and Utilities have a rich vein
            of research and management consulting material available on pricing
            strategies and their impact.
            Professional services industries are less well served, and in many
            instances, pricing in professional services hasn’t progressed beyond
            charging for chunks of time worked.
            This presentation deals with more complex opportunities where we
            want to deliver an outcome that may involve many
            people, subcontractor, payment milestones, risks and financial
            provisions.
            If that interests you, then its worth looking through this presentation.
John Phillips - au.linkedin.com/in/johnphillips11kps/
How can I get a handle on how important this
            is?




                 Everyone gets that price is important, but sometimes we need a reminder of how
                 important even small improvements can be.
                 One simple, real-world business based example was provided by Compustat and
                 McKinsey, where a 1% increase in average price can realise an 8% improvement in gross
John Phillips - au.linkedin.com/in/johnphillips11kps/
Alternatively, you can quote Warren Buffet

            “The single most important decision in evaluating a business is
            pricing power. If you’ve got the power to raise prices without
            losing business to a competitor, then you’ve got a very good
            business. And if you have to have a prayer session before raising
            the price by 10%, you’ve got a terrible business.”

            It should perhaps be noted that the source of this oft-repeated quote was Warren Buffet’s
            explanation during the Federal Crisis Investigations Committee’s early 2011 interview when he
            was being asked about his investment in Moody’s Corp. Bloomberg’s piece proposed that, for
            Warren Buffett, it seemed that pricing power was more important than good management. If
            possible, I’d rather have both!




John Phillips - au.linkedin.com/in/johnphillips11kps/
So what does the big picture look like?




John Phillips - au.linkedin.com/in/johnphillips11kps/
Looks complex. Let’s build the picture up and
explain each element as we introduce it




             John Phillips - au.linkedin.com/in/johnphillips11kps/
Reminder: we assume that you’re building an
            estimate of the cost to deliver and outcome
            Typical scenarios might be work in the engineering services
            industry, communications technology and information systems
            industry, construction industry etc.
            Key elements are:
            – A definition of the scope of the work that is good enough to
               allow an estimate
            – Something that your company has the skillset to do, in whole
               as the prime contractor, or in part as a team member
            – Something that’s worth doing - that delivers value to the
               customer


John Phillips - au.linkedin.com/in/johnphillips11kps/
First we build up our estimate of the cost to
            deliver the outcome

                                                        That’s this ‘stack’
                                                        part of our model




John Phillips - au.linkedin.com/in/johnphillips11kps/
Labour costs are the costs of our own effort in
            delivering the outcome
            In our model, labour costs are the total effort multiplied by the cost rate for
            each person.
            You’ll need to consider the impact of inflation if the time to deliver the
            outcome is considerable (months or years say), and/or if the delivery period
            covers a known salary uplift.
            We like to separate out the basic cost of employment for each individual from
            the overheads associated with their office location.
            We do not include contingency in the base effort estimate – that comes later.




                                                        Labour


John Phillips - au.linkedin.com/in/johnphillips11kps/
Overheads are non-direct labour operating costs
            that we need to recover
            We like to separate out the overheads that need to be recovered from the
            basic labour cost so that we can allow for projects that have significant on-site
            effort and/or clients that pay for accommodation and other costs. It also
            means that low-cost / overhead centres can be more easily seen and taken
            advantage of.
            The overheads we consider are typically location based costs associated with
            each resource and other operational costs and the total cost is derived from
            effort x overhead. Remember inflation here too.




                                                        Overheads

                                                         Labour


John Phillips - au.linkedin.com/in/johnphillips11kps/
Materials and Expenses are things that we need
            to buy or pay for to deliver the outcome
            These costs can be expenses such as flights, hotels, taxis, meals. We might
            need to purchase items like computers or software, or even large material
            items to complete the delivery.
            We separate out materials and expenses as the nature of their procurement
            and reimbursement are generally quite different.
            Remember inflation here too.




                                                        Materials and Expenses
                                                             Overheads

                                                               Labour


John Phillips - au.linkedin.com/in/johnphillips11kps/
Subcontractors are those other companies, or
            individuals that we need to add to the team
            Subcontractors are companies and/or individuals that we need to add to our
            team for their specific expertise and to make our offer more attractive to the
            client. Their costs may be fixed (through agreement), or variable and based
            on agreed rates. The difference is important to the risk profile of using
            subcontractors.
            Remember inflation here too.




                                                           Subcontractors
                                                        Materials and Expenses
                                                             Overheads

                                                               Labour


John Phillips - au.linkedin.com/in/johnphillips11kps/
Cash flow charges consider the cost of the
            working capital forecast for the project
            Any of us that have been responsible for a business, our own or someone
            else’s, will understand the importance of cash – money in our bank. The
            concept here is that being paid 180 days after we’ve incurred the expense is
            not as good as being paid 30 days after the expense, and certainly not as
            good as being paid before the expense is incurred. Cash Flow charges are
            based on the monthly Working Capital forecast for the project and use a
            monthly interest / charge rate to encourage positive cash-flow (the monies
            we’ve been paid exceed the costs we forecast at each point of the project)

                                                         Cash Flow Charges
                                                           Subcontractors
                                                        Materials and Expenses
                                                             Overheads

                                                               Labour


John Phillips - au.linkedin.com/in/johnphillips11kps/
Contingency is the amount of extra cost that we
            think we may incur
            There are sophisticated approaches to considering risk and contingency. Here
            we are noting that for any outcome where there is uncertainty, we need to
            consider what the risks are, what their impact would be, how we might
            mitigate them, and what we would need to do if they occur.
            The end result is that we have some risks we can’t avoid and that we should
            have an appropriate amount of contingency to cover.

                                                             Contingency

                                                         Financial Provisions
                                                         Cash Flow Charges
                                                           Subcontractors        Total cost of
                                                        Materials and Expenses   contract delivery
                                                             Overheads

                                                               Labour


John Phillips - au.linkedin.com/in/johnphillips11kps/
Next we look at four price points
                                                                                 Client Value Proposition
                   Price Ceiling
                   (determined by
                   value to client of                                                   (determined by pricing strategy
                                                                        Price Target    and company’s value
                   contract delivery)
                                                                                        proposition to client)
                                   Competitor’s
                                    price points
                                                                                       Negotiating
                                                                                       Margin

                      Price Floor
                      (determined by delivery                                          Minimum commercially
                      scope, approach,                                                 acceptable margin for contract
                      operating costs and                    Contingency
                      minimum margin)
                                                         Financial Provisions
                                                         Cash Flow Charges
                                                           Subcontractors               Total cost of
                     Simple pricing                                                     contract delivery
                                                        Materials and Expenses
                     model for a
                                                             Overheads
                     single valued
                     price and a fixed                         Labour
                     scope of supply
John Phillips - au.linkedin.com/in/johnphillips11kps/
First we need to know what our price floor is –
            the lowest commercially acceptable margin
            The price floor is determined by the minimum commercial margin that makes
            sense to achieve for this contract, based on our understanding of the cost to
            deliver. You can think of it as “what do I need to get as a minimum return to
            make this worthwhile (and not be better off keeping the money in the bank)”

                      Price Floor
                                                                                 Minimum commercially
                                                                                 acceptable margin for contract
                                                             Contingency

                                                         Financial Provisions
                                                         Cash Flow Charges
                                                           Subcontractors         Total cost of
                                                        Materials and Expenses    contract delivery
                                                             Overheads

                                                               Labour


John Phillips - au.linkedin.com/in/johnphillips11kps/
Then we need to know what its worth for the
            client – this gives a price ceiling
                                                                                 Client Value Proposition
                   Price Ceiling


            Here we want to know why the client want’s this outcome achieved. What’s it
            “worth” to them? What commercial (or other) gain to they seek to make on
            completion?
            Knowing this gives us a theoretical price ceiling - it would make no sense to
                Price Floor
            charge at or above this ceiling as it leaves the clientMinimum commerciallyon their
                                                                    with no return
                                                                   acceptable margin for contract
            investment.                      Contingency

                                                         Financial Provisions
                                                         Cash Flow Charges
                                                           Subcontractors              Total cost of
                                                        Materials and Expenses         contract delivery
                                                             Overheads

                                                               Labour


John Phillips - au.linkedin.com/in/johnphillips11kps/
And then we should think about where our
            competitors will price, and why
                                                                              Client Value Proposition
                   Price Ceiling                            Its likely that our competitors will have prices
                                                            that vary from each (determined by pricing strategy
                                                                                  other, sometimes
                                                                     Price Target and company’s value
                                                            dramatically.         proposition to client)
                                   Competitor’s
                                    price points              Each will be based on a combination of their
                                                                                    Negotiating
                                                              understanding of the outcome sought by the
                                                                                    Margin

                      Price Floor                             client (the scope), their cost to deliver that
                                                              outcome, what they thinkcommercially
                                                                                   Minimum
                                                                                              their unique value
                                                                                   acceptable margin for contract
                                                              proposition is, and perhaps whether they’re
                                                             Contingency

                                                         Financial Provisions or aggressive.
                                                              feeling lucky
                                                         Cash Flow Charges
                                                              Knowing as much as wecost of about where
                                                           Subcontractors          Total
                                                                                         can
                                                        Materials andmight price helps to shape our decision
                                                              they Expenses        contract delivery

                                                            to compete.
                                                            Overheads

                                                              Labour


John Phillips - au.linkedin.com/in/johnphillips11kps/
Our target price considers our own pricing
            strategy and what we know of our competitors
                   Price Ceiling
                                                                  Price Target


            Our chosen price target is determined by our value proposition to the client.
            It should reflect our understanding of their price ceiling, our price floor and
                 Price Floor
            be consistent with our own pricing strategy (are we a premium provider, or a
            high volume low margin body shop?).
                                            Contingency
            Note that while we would like to know our competitor’s pricing strategy,
                                        Financial Provisions
            ultimately we should care more about our own. Our potential price should be
                                         Cash Flow Charges
            determined by our unique value proposition to our clients – why they choose
                                          Subcontractors
                                       Materials and Expenses
            us over our competitors and how much they are prepared to pay.
                                                        Overheads

                                                         Labour


John Phillips - au.linkedin.com/in/johnphillips11kps/
So that’s the big picture explained. Now let’s see
            one example of how to use it…




John Phillips - au.linkedin.com/in/johnphillips11kps/
We can use the picture to see the choices we
            need to make under different circumstances
                              Nominal situation – we determine a price
                              within client expectations, the competitive
                                 environment and our value proposition




                                                                  Rare but still all too common situation - the client's
                                                                  expectation of price is below our cost to deliver.
                                                                  Things to consider:
                                                                  - Can we use a different delivery approach?
                                                                  - Can we deliver something different (scope)?
                                                                  If neither work, then we should qualify out.
John Phillips - au.linkedin.com/in/johnphillips11kps/
That’s all folks

                                                        Hope you enjoyed the slides.




John Phillips - au.linkedin.com/in/johnphillips11kps/

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Cost to deliver elements and price points for professional services

  • 1. Cost Estimation and Pricing in Professional Services Delivery An introduction to a big picture representation of calculating the cost to serve and identifying three price points John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 2. Worthy but boring title? Is it worth me looking through this presentation? There is a wealth of research, data and special interest groups on pricing strategies and approaches related to products. For example, industries such as Fast Moving Consumer Goods, Consumer Electronics, Automotive and Utilities have a rich vein of research and management consulting material available on pricing strategies and their impact. Professional services industries are less well served, and in many instances, pricing in professional services hasn’t progressed beyond charging for chunks of time worked. This presentation deals with more complex opportunities where we want to deliver an outcome that may involve many people, subcontractor, payment milestones, risks and financial provisions. If that interests you, then its worth looking through this presentation. John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 3. How can I get a handle on how important this is? Everyone gets that price is important, but sometimes we need a reminder of how important even small improvements can be. One simple, real-world business based example was provided by Compustat and McKinsey, where a 1% increase in average price can realise an 8% improvement in gross John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 4. Alternatively, you can quote Warren Buffet “The single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, then you’ve got a very good business. And if you have to have a prayer session before raising the price by 10%, you’ve got a terrible business.” It should perhaps be noted that the source of this oft-repeated quote was Warren Buffet’s explanation during the Federal Crisis Investigations Committee’s early 2011 interview when he was being asked about his investment in Moody’s Corp. Bloomberg’s piece proposed that, for Warren Buffett, it seemed that pricing power was more important than good management. If possible, I’d rather have both! John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 5. So what does the big picture look like? John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 6. Looks complex. Let’s build the picture up and explain each element as we introduce it John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 7. Reminder: we assume that you’re building an estimate of the cost to deliver and outcome Typical scenarios might be work in the engineering services industry, communications technology and information systems industry, construction industry etc. Key elements are: – A definition of the scope of the work that is good enough to allow an estimate – Something that your company has the skillset to do, in whole as the prime contractor, or in part as a team member – Something that’s worth doing - that delivers value to the customer John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 8. First we build up our estimate of the cost to deliver the outcome That’s this ‘stack’ part of our model John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 9. Labour costs are the costs of our own effort in delivering the outcome In our model, labour costs are the total effort multiplied by the cost rate for each person. You’ll need to consider the impact of inflation if the time to deliver the outcome is considerable (months or years say), and/or if the delivery period covers a known salary uplift. We like to separate out the basic cost of employment for each individual from the overheads associated with their office location. We do not include contingency in the base effort estimate – that comes later. Labour John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 10. Overheads are non-direct labour operating costs that we need to recover We like to separate out the overheads that need to be recovered from the basic labour cost so that we can allow for projects that have significant on-site effort and/or clients that pay for accommodation and other costs. It also means that low-cost / overhead centres can be more easily seen and taken advantage of. The overheads we consider are typically location based costs associated with each resource and other operational costs and the total cost is derived from effort x overhead. Remember inflation here too. Overheads Labour John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 11. Materials and Expenses are things that we need to buy or pay for to deliver the outcome These costs can be expenses such as flights, hotels, taxis, meals. We might need to purchase items like computers or software, or even large material items to complete the delivery. We separate out materials and expenses as the nature of their procurement and reimbursement are generally quite different. Remember inflation here too. Materials and Expenses Overheads Labour John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 12. Subcontractors are those other companies, or individuals that we need to add to the team Subcontractors are companies and/or individuals that we need to add to our team for their specific expertise and to make our offer more attractive to the client. Their costs may be fixed (through agreement), or variable and based on agreed rates. The difference is important to the risk profile of using subcontractors. Remember inflation here too. Subcontractors Materials and Expenses Overheads Labour John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 13. Cash flow charges consider the cost of the working capital forecast for the project Any of us that have been responsible for a business, our own or someone else’s, will understand the importance of cash – money in our bank. The concept here is that being paid 180 days after we’ve incurred the expense is not as good as being paid 30 days after the expense, and certainly not as good as being paid before the expense is incurred. Cash Flow charges are based on the monthly Working Capital forecast for the project and use a monthly interest / charge rate to encourage positive cash-flow (the monies we’ve been paid exceed the costs we forecast at each point of the project) Cash Flow Charges Subcontractors Materials and Expenses Overheads Labour John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 14. Contingency is the amount of extra cost that we think we may incur There are sophisticated approaches to considering risk and contingency. Here we are noting that for any outcome where there is uncertainty, we need to consider what the risks are, what their impact would be, how we might mitigate them, and what we would need to do if they occur. The end result is that we have some risks we can’t avoid and that we should have an appropriate amount of contingency to cover. Contingency Financial Provisions Cash Flow Charges Subcontractors Total cost of Materials and Expenses contract delivery Overheads Labour John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 15. Next we look at four price points Client Value Proposition Price Ceiling (determined by value to client of (determined by pricing strategy Price Target and company’s value contract delivery) proposition to client) Competitor’s price points Negotiating Margin Price Floor (determined by delivery Minimum commercially scope, approach, acceptable margin for contract operating costs and Contingency minimum margin) Financial Provisions Cash Flow Charges Subcontractors Total cost of Simple pricing contract delivery Materials and Expenses model for a Overheads single valued price and a fixed Labour scope of supply John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 16. First we need to know what our price floor is – the lowest commercially acceptable margin The price floor is determined by the minimum commercial margin that makes sense to achieve for this contract, based on our understanding of the cost to deliver. You can think of it as “what do I need to get as a minimum return to make this worthwhile (and not be better off keeping the money in the bank)” Price Floor Minimum commercially acceptable margin for contract Contingency Financial Provisions Cash Flow Charges Subcontractors Total cost of Materials and Expenses contract delivery Overheads Labour John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 17. Then we need to know what its worth for the client – this gives a price ceiling Client Value Proposition Price Ceiling Here we want to know why the client want’s this outcome achieved. What’s it “worth” to them? What commercial (or other) gain to they seek to make on completion? Knowing this gives us a theoretical price ceiling - it would make no sense to Price Floor charge at or above this ceiling as it leaves the clientMinimum commerciallyon their with no return acceptable margin for contract investment. Contingency Financial Provisions Cash Flow Charges Subcontractors Total cost of Materials and Expenses contract delivery Overheads Labour John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 18. And then we should think about where our competitors will price, and why Client Value Proposition Price Ceiling Its likely that our competitors will have prices that vary from each (determined by pricing strategy other, sometimes Price Target and company’s value dramatically. proposition to client) Competitor’s price points Each will be based on a combination of their Negotiating understanding of the outcome sought by the Margin Price Floor client (the scope), their cost to deliver that outcome, what they thinkcommercially Minimum their unique value acceptable margin for contract proposition is, and perhaps whether they’re Contingency Financial Provisions or aggressive. feeling lucky Cash Flow Charges Knowing as much as wecost of about where Subcontractors Total can Materials andmight price helps to shape our decision they Expenses contract delivery to compete. Overheads Labour John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 19. Our target price considers our own pricing strategy and what we know of our competitors Price Ceiling Price Target Our chosen price target is determined by our value proposition to the client. It should reflect our understanding of their price ceiling, our price floor and Price Floor be consistent with our own pricing strategy (are we a premium provider, or a high volume low margin body shop?). Contingency Note that while we would like to know our competitor’s pricing strategy, Financial Provisions ultimately we should care more about our own. Our potential price should be Cash Flow Charges determined by our unique value proposition to our clients – why they choose Subcontractors Materials and Expenses us over our competitors and how much they are prepared to pay. Overheads Labour John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 20. So that’s the big picture explained. Now let’s see one example of how to use it… John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 21. We can use the picture to see the choices we need to make under different circumstances Nominal situation – we determine a price within client expectations, the competitive environment and our value proposition Rare but still all too common situation - the client's expectation of price is below our cost to deliver. Things to consider: - Can we use a different delivery approach? - Can we deliver something different (scope)? If neither work, then we should qualify out. John Phillips - au.linkedin.com/in/johnphillips11kps/
  • 22. That’s all folks Hope you enjoyed the slides. John Phillips - au.linkedin.com/in/johnphillips11kps/