Cost Analysis and Estimating for Engineering and Management

Cost Analysis and Estimating for Engineering and Management Chapter 8 Product Estimating © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -1

Overview l Processes for Determining Price -Bottom Up and Top Down l Using Productive Hour Costs l Learning in Product Cost Estimating l Methods to Establish Price l Purchasing Contracts l Benchmarking © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -2

The Product Estimate l Must Include All Parts -All Operations, Direct and Indirect -Overhead, Engineering, Sales l Determines -Price, Cost, Profit -Cash Flow, Rate of Return -Labor Requirement, Scheduling © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -3

Market Place l Market Determines Price Paid l Attainable Price Should Exceed Cost l Price Also Determines Quantity Sold l Price from the “Top Down” -Sets Allowable Costs © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -4

Price Elements © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -5

Estimated Cost l Components of “Cost of Goods Manufactured” and Overhead (Gen & Admin) Previous Discussions l Engineering and Sales l Contingencies -Provides for Unknowns -Radically New Products/Processes -Not for “Pad” or Poor Estimates © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -6

Product Cost Elements © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -7

Selecting Method vs Quantity © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -8

Engineering Costs l Design of the Product l R & D l Engineering for Products Not Produced l Support Engineering -Manufacturing, Industrial -Test, QC © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -9

Handling Engineering Costs l Overhead -Mass Production, Few New / Changes l Separate Line Item(s) -High Tech, Services l Amortize to Products Produced Eq 8. 1 © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -10

Finding Engr Costs l Include All Elements -Salaries -Expenses -Overhead -Fees Paid Ce = S + E + OH + F Eq 8. 2 © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -11

Example of Engr Costs Work Category Hr Rate / hr Totals Engineer, senior design 40 $33. 00 $1, 320 Engineer, design 800 30. 00 24, 000 Designer/engineering. aide 160 18. 75 3, 000 CAD operator 80 17. 00 1, 360 Total Engineering Labor 1080 $29, 680 © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -12

Information for Estimating l Need to Know: -What Does It Look Like? -How Many? (Will Be Made) l Determines: -Manufacturing Processes -Labor Requirements © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -13

RFE Should Include l Engineering Documents -Drawings, BOM Specs l Schedule Dates -Estimate, Production l Build Quantities © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -14

Bill of Material l One for Every Part and Assembly l Collect from the Top Down l Include Quantities l Assemble a Structure (Tree) to Collect Estimates - From the Bottom Up l Estimate Individual Parts and Assembly © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -15

Product Tree with Costs © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -16

Costed Bill of Material Lvl Desc Qty Next Unit Matl Unit Labor Total Unit Cost to Next 1 2 2 3 3 3 3 Top Gskt Tank Chas Screw Assy Hatch Sheet Stiffer Chas Screw N/A 1 1 4 4 1 8 4 2 3 8 $396. 24 0 10. 41. 10. 04 6. 68 46. 22 9. 57 2. 39. 10. 04 $17. 21 2. 39. 24. 04 0 3. 01 1. 68. 52. 17. 04 0 $413. 45 2. 39 10. 65. 14. 04 9. 69 47. 90 10. 09 2. 56. 14. 04 ---2. 39 10. 65. 56. 16 9. 69 383. 2 40. 36 5. 12. 42. 32 © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -17

Compiling the Estimate l Need to Determine Full Cost -Includes Overhead Allocations l Two Methods -Productive Hour Cost (PHC) -Activity Based Costing (ABC) l The Product Estimate is a Formal Document © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -18

PHC Method l Labor Estimates in Hours l Need “Rate” to Multiply for Cost l PHC Rate (Section 4. 9. 5) l Labor Including -Wages, Fringes, Overhead, Indirect l Machine Costs © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -19

Calculating PHC Costs l Total Unit Cost Eq 8. 3 l Total Product Cost Eq 8. 6 © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -20

PHC Cost Example © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -21

Activity Based Costing (ABC) l PHC Ties Overhead to All Products without Regard for What Is Used l ABC Attempts to Allocate Overhead to Products Usage -What Is Used -How Much Is Used © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -22

ABC Concepts l Associate Overhead Costs to Activities l Predetermine O/H Costs per Unit of Activity -Units May Not Always Be Hours -Total Expected Cost Divided by Total Expected Units of Activity for Rate -e. g. Purchasing Dept Cost / No. of POs © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -23

Using ABC for an Estimate l Determine O/H Activities Needed l Determine Amount of Each Activity l Use Rate for Each Activity Eq 8. 7 © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -24

Learning at the Product Level l Performance Improves with Experience l First Unit Labor Hours Depend on -Company Experience -Amount of Preparations -Product Characteristics l Apply Learning Factor per Cost Element Eq 8. 8 © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -25

Sources for Improvement l Operator (15%) l Design (50%) l Manufacturing Engineering (35%) l Requires Specific Effort l Best Candidate Products -High Cost, Low Volume © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -26

Learning Uses l Price Negotiations l Make-Buy Decisions l Product Cost Based on Prototype l Costs for Additional Orders -Follow-On Procurement -Engineering Change Orders -Breakeven Analysis © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -27

Follow-On Procurement l Ref. Chapter 6 (Learning) l Determine a Learning Curve (K, s) l Calculate Total Costs l Subtract Cost for First Units from Cost of All Units Through Follow On Build © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -28

Engineering Change Order (ECO) l Design Change(s) to Existing Product l ECO Affects Future Units l Does ECO Require Change (Retrofit) to Existing Units (Prior Production)? l Is There a Change to Cost? © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -29

Simple ECO (No Retrofit) © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -30

ECO with Retrofit © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -31

Calculating a Retrofit ECO 1) Find Cost for Production of Existing 2) Find Retrofit Cost 3) Find Cost for Continuing Production From ECO Incorporation to End of Run 4) Sum 1 -3 Above 5) Compare to Cost without ECO © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -32

Breakeven with Learning l Conventional Breakeven Assumes Variable Cost Is Constant Pnbe = nbe Cv + Cf Eq 8. 9 l Learning Assumes Variable Cost Decreases Eq 8. 10 © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -33

Conventional Breakeven © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -34

Breakeven with Learning © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -35

Determining Price l Market Determines “Economic Want” l Supply and Demand l Price Customer Will Pay l Customer’s Price Includes -Vendors Price (Cost Plus Profit) -Transportation Costs -Wholesale & Retail Costs and Profit © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -36

Producer’s Price l For Engineering Estimating -Expected Price Minus Expected Cost l Estimated Profit May NOT Equal Actual Profit l Engineering Wants Costly Designs l Manufacturing Over-Estimates Costs l Marketing Wants Low Price l Need “Reasonable” Compromise © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -37

Pricing Concepts l Price Proportional to (Total) Cost l Price Proportional to Conversion Cost l Price Proportional to Variable Cost l Price Determined by Market l Price Is Not Always the Sole Basis for Competition © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -38

Judgment Pricing l Experience l Discussion (Opinion, Conference, Comparison) l Future Will Not Be Like the Past © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -39

Markup on Cost l Full Cost Eq 8. 11 P = Ct + Rm(Ct) l Value Added (Direct Labor + Overhead) P = Cdl(1 + Roh)(1 + Rm) + Cdm Eq 8. 12 l Direct Cost (Labor + Materials) P = ( Cdl + Cdm)(1 + Rm) + Coh Eq 8. 13 © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -40

More Markup l Return on Investment -Return Must Exceed Capital Cost Eq 8. 14 l Markup on Sales Eq 8. 15 © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -41

Contribution l Price Based on Variable Costs Eq 8. 16 l Contribution Is the Amount Left After Paying Variable Costs l Covers Fixed Costs and Profit © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -42

Price Estimating Relationships l Prices Predicted Over a Period of Time l Market Establishes a Price Ceiling l Producer Establishes a Price Floor -Cost Plus Profit Required l Difference Is the Opportunity Margin l Supply and Demand Controls © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -43

Opportunity Margin l Can Be Used to Set Price l Prices Usually Decline with Time l Also Determines Life Cycle l Market Model Eq 8. 17 © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -44

Opportunity Margin Model © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -45

Break Even with Margins © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -46

Contracts l Buying and Selling Involves Contracts -Purchase Orders -Quotations / Estimates -Legal Consequences l Two Types of Sales Contracts -Firm Fixed Price -Cost-Reimbursable © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -47

Fixed-Price Contracts l Used for -Low Tech, Well Developed Products -High Quantities -Short Duration l Supplier Assumes Risks If Costs Go Up l Supplier Benefits from Any Savings l Buyer Benefits from Known Price © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -48

Fixed-Price Based on Hourly Cost l Quoted Hourly Rate (PHC + Profit) l Multiplied by Actual Time Spent l Used If Job Scope Is Unpredictable l Sometimes Bid as “Time and Materials” l Also: -Quote or Price in Effect -Pass Through Material Cost Increases © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -49

Cost Reimbursement l High Technology l High Risk l Low Degree of Definition l Customer Assumes Most or All of Risk -Negotiated Risk/Benefit Sharing Proportion l “Cost Plus” a Fee or Profit -Negotiated, Sometimes with Incentives © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -50

Other Uses for Estimates l Make / Buy Decisions l Breakeven Analysis l Value Engineering l Concurrent Engineering -DFM and DFA -Design to Cost © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -51

Make vs. Buy l Be Sure to Compare Equal Situations -If Make Cost Includes Design Cost -Design Cost Must Be Added to Buy Price l Include ALL Costs of Buying -Transportation -In House Costs for Purchasing/Receiving -Intangibles (Quality, Schedule, etc) © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -52

Concurrent Engineering l Saves Money and Time l Reduces Changes and Time to Market l Recognizes Cost as a Design Reqm’t l Savings -30% Less Development Time -65% Fewer Engineering Changes -20% Less Time to Market © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -53

Benchmarking – Exclusion Chart © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -54

Benchmarking – Feature Map © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -55

Benchmarking – Envelope Fan © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -56

Benchmarking – Design to Cost © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -57

© 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -58

© 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -59

© 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -60

Summary l Determined Product Costs -Applied Learning and PHC l Studied Tools for Establishing Prices -Bottom Up and Top Down l Looked at Purchasing Contracts l Peeked into the Future of Estimating © 2004 Pearson Education, Inc. Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ostwald and Mc. Laren / Cost Analysis and Estimating for Engineering and Management Ch 8 -61