Professional Services - Introduction to Job Costing

November 2002

Dear Ndarala Colleagues

In my first Group report this month I looked briefly at financial metrics. I mentioned the importance of proper identification and management of work in progress. In this report, I want to look at a related issue, the importance of proper job costing.

Why is Job Costing Important?

Many of our own colleagues, and they are not unique, do not undertake structured job costing. Working from experience, they hold a finger in the air and come up with an estimated price.

This approach is not necessarily wrong. In many cases, their experience means that they come in within a small percentage of the final job cost. Further, job costing itself has a cost, a cost that the customer may be unwilling to pay. Yet while this experiential based approach to costing may be correct in some circumstances, it can be disastrous in others.

A number of years ago my then consulting company was commissioned by the Australian Government to carry out a survey of telecommunications research within Australian tertiary institutions. Part way into the job the time sheets showed that we were facing a major work in progress write off on the job. That is, we were losing money.

After discussions with my senior research officer who was in charge of the survey component of the job, I looked at the costing sheets. I found that we had grossly underestimated the number of contacts and the time of each contact required to get a valid survey response. This of itself was sufficient to put the job into the red.

Two points. First, having got the costing wrong, nothing could prevent a bad outcome in financial terms, although the client itself was very happy with the job outcome. Secondly, the fact that we had done proper costing and also had good time recording systems meant that we were at least able to identify the problem and take some corrective action.

At the same time this job was going through, we were one of two companies short listed by the Australian Department of Defence for a census of Australias ship building and ship repair industry.

At the time, we were at bottom of the 1991 economic trough. We needed the job badly, put a lot of effort into the proposal, and shaved everything to get a good price including a substantial but unstated discount on our real charge rates. According to the Department our methodology was clear and developed, far better than the short listed firm. They wanted us, but needed to get us to cut the price so that they could get it through their system.

We really agonized on this one. We needed the work. But because we had done the costing we knew that the risks were just too great. So we walked away. This was the right decision. The contract was awarded to one of the best known big shops that had an underutilsed survey unit. Their costing had been done so badly that they did not even recover cash out costs. The unit was subsequently closed.

Defining Client Need

Good costing starts with a proper definition of client need. I know that this sounds self-evident, but far too many consultants go straight from brief or client instructions to solution.

This is normally a recipe for costing disaster. To cost something, you must first define it. You may define your solution properly and even get the job, but if your solution is not in fact what the client wants (and the client may not realize this), then you are facing extra work round costs as the gap become clear. And it will.

The Group's proposal manual as well as our short guide to project management contains clues as to ways of defining client need. However, in broad terms:

• Start be defining the results the client wants to achieve from the assignment.
• Then test this by looking at the way the client wants to use the results from the assignment. Note here that outputs (the defined deliverables) and outcomes (the use that the client wants those deliverables too) may be very different. And the client may not even be aware of those differences!
• Then look at any instructions the client may have given as to the process to be followed in carrying out the assignment. In theory, it is up to the consultant to define the process to be followed. In practice, and especially with Government tenders, the process is mandated in the tender brief.
• Then think about how you might do the job, taking outputs, outcomes and process instructions into account.

Having followed this process, you will often find tensions and inconsistencies built into the brief. These need to be clarified with the client.

Defining the Initial Approach

If you have followed a structured approach to defining client need, you will have a pretty fair idea as to just what you might do. You now need to translate this into a defined approach. Remember, this has to be specified with sufficient clarity to allow you to do proper costings.

The starting point here is to break the job up into modules, major building blocks that must be completed if the project is to work. In each case, you need to specify inputs (what is required to complete the module) and outputs (what are the expected results, how they will be used). As part of the process, you need to specify the relationships between the modules.

A simple flow chart can help here. Take a blank sheet of paper, put down the modules as circles, draw a line between the circles expressing the relationships between them.

Then take each module and break it up into process steps. We know what we have to do, how will we do it?

Defining a Base Line Budget

We use the term base line budget to describe the initial job budget based on the initial defined approach. This now needs to be costed.

Likely disbursements are usually reasonable easy. If you are to meet with the client and this involves travel, then its not hard to get travel costs. Time inputs are far more difficult.

To get time inputs, take each defined process step and work out how long it will take expressed in terms of hours or days. Where different people or job levels are involved, you will need to break your time estimates up by people or level.

Now there is a trick here. We know from experience that we always underestimate how long it will take to do something. The underestimate varies from +50 per cent for a very experienced estimator to up to 3 times for a novice. As a very rough rule of thumb, for base line budget purposes simply double your initial estimate. You can now generate a time cost estimate by multiplying your time estimates by the relevant charge rate.

Reviewing the Base Line Budget

From experience, the base line budget will nearly always exceed what the client is willing to pay. So you need to refine.

There are two ways of doing this.

First, look again at the process you have defined. Are there any steps that can be cut out, reduced?

Second, look at you time estimates. Can you reduce time inputs in any steps?

Having followed this process you will have a new budget. This may need to be refined several times, following the same process. Even then, your costs may be too high.

Now we come to a crunch point. Be prepared to walk away if all your analysis shows that you cannot do the job for the price the client wants, You have to make a decent living.

All for now.

Good hunting.

Jim Belshaw
CEO Ndarala Group.