Other Cost Considerations

Monitoring Other Direct Costs (ODCs). The overall project budget shown in Table 3.4 shows other direct costs (ODCs) as a separate category of costs, which may include such items as travel, computer services, equipment, consultants, subcontractors, mailing, reproduction, telephone, materials, software, and other types of costs. Many of these costs come in late and therefore lag the normal reporting cycle times. The PM must be aware of these costs and commitments and make sure that they are not lost in the reckoning of the project cost picture. Many PMs have been surprised by late inputs of these types of costs simply because they were forgotten or lost in company processing. The PM should assign this tracking responsibility to the PC so that these costs do not appear as a late and not very welcome surprise.

A particular type of ODC requiring special attention is subcontracting. If a PM is in a position where subcontracting is a major part of the project, or critical path events depend on the delivery of a subcontract product or service, then unique steps may need to be taken to assure there is no victimization by the subcontractor. Some very large projects have dozens of subcontractors, thus increasing manyfold the likelihood of a significant problem. Some actions for a PM under these circumstances include:

1. Placing project personnel at the subcontractor's facility to monitor status and progress

2. Establishing interface control and documentation as a more prominent aspect of the systems engineering effort

3. Holding more frequent status review sessions for subcontractors

4. Meeting with the management of the subcontractors to obtain commitment to cost, schedule, and performance requirements

5. Providing parallel developments and backup sources as insurance, if they can be afforded

6. Using incentive award contracts for on-time, high-quality deliveries

Monitoring for Different Contract Types. The way in which information is aggregated and reported is also related to the type of contract under which the project is being carried out. We discuss some of the vagaries of monitoring for three generic contract types:

1. Cost contracts

2. Fixed-price contracts

3. Time and materials (T&M) contracts

Cost contracts include cost-plus-fixed-fee (CPFF), cost-plus-incentive-fee (CPIF), cost-plus-award-fee (CPAF) contracts and variations on this basic theme. All such contracts mean that the customer pays the basic costs of the contract and the fee can be fixed or variable. Such contracts are prevalent in the world of government contracting and are almost never used in the commercial arena. Under an arrangement where under most conditions all costs are covered and guaranteed, there is sometimes not a strong incentive for a company to control costs to the budgeted numbers. However, it is strongly recommended that the PM adopt a point of view that such control is mandatory. It is generally not a good idea to lose the discipline of cost control, even when there is not a strong penalty for overrunning a contract. Cost reports for a cost contract are precisely those that have been shown in this chapter. Each element of cost is monitored and tracked, and corrective action is taken whenever actual costs begin to exceed budgeted values.

Incentive- and award-fee cost contracts are recommended in order for the system acquisition agent (customer) to make sure the contractor focuses on meeting the cost, schedule, and performance requirements. Incentive- and award-fee parameters can be defined so as to reward contractors for emphasizing the items most important to the customer. Experience has shown that these types of contracts are quite effective in motivating contractors. Explicit evaluations and scoring by the customer also provide periodic feedback to the contractor so that the positions and issues of both parties are known as the contract proceeds. A PM who is not getting good evaluation scores is likely not to be achieving fee (profit) goals. This gets the immediate attention of both the PM and management.

Fixed-price contracts basically mean that the contractor works on the contract until all requirements and specifications are satisfied. Costs in excess of the original budget are borne by the contractor. Thus, if budgeted costs are exceeded, profit dollars are jeopardized. Such contract forms are utilized almost exclusively in the commercial world, and increasingly in the government arena.

A PM working under a fixed-price contract should be aware that every dollar ''saved'' is one that could be added to the profit made under that contract. There is a tendency, therefore, for such contracts to be monitored extremely carefully, always looking for a better solution that will satisfy requirements within cost and schedule constraints. It should also be noted that, at times, such contracts have penalty clauses. A typical clause of this type penalizes the company for late delivery of the product. In this fashion, the customer makes it clear that meeting schedule is a very important issue, and failure to do so may force both the contractor and the customer to experience increased costs.

Cost reports for fixed-price contracts can take the same form illustrated in this chapter, as each element of cost is tracked on a periodic basis. A PM may wish to shorten the periodicity of such reports, such as getting a weekly reading of costs instead of the more usual monthly report. This can place a strain on the company accounting system, which may not be geared to such rapid reporting. In such cases, PMs have been known to generate their own interim cost reports in order to satisfy their needs. This may be done by capturing weekly time charges on Friday afternoon and feeding them in to a spreadsheet developed by the Project Controller, so that by the Monday following the week in question, a weekly cost report is available. This type of special reporting is recommended for all contracts as they near their completion times when it may be necessary to exercise more stringent controls.

Both cost and fixed-price contracts may also include the requirement of a minimum delivery of hours. At times, a ''window'' of ±10% of the bid number of hours is established and placed into the contract document itself. Thus, if more experienced personnel than originally proposed are used on the work, it may turn out that the ''-10%'' requirement is not satisfied. This normally results in some type of fee penalty. Where there is a requirement for delivery of hours, the PM must also be monitoring hours expended, by category, to make sure that the hours are actually delivered as per the contract. In this regard, we note the ''hours'' columns in Table 4.2. ''Hours expended'' reports for such a situation must become part of the normal process of tracking projects.

A time and materials (T&M) contract is usually set up on the basis of a customer requirement that a certain number of hours be purchased, at a fixed rate by personnel category. The customer is thus buying expertise, by the hour, for various categories of personnel. The essence of the contract lies in the delivery of such expertise, and the customer paying a fixed amount for each hour delivered. Of course, the expertise must be sufficient to satisfy the customer's requirements. If it is not, the customer will insist upon a change of personnel. Materials called for under the contract (e.g., computers and COTS software) are delivered separately, with an agreed-on markup or at cost. The overall contract, of course, has a ceiling price that the customer has agreed to.

Monitoring a T&M contract normally requires cost reports different from those shown previously in this chapter. Not only does overall cost need to be tracked, but hours by category and associated costs must be monitored in detail. The basic reason is that the actual people assigned to work may be at the ''high end'' of their categories. Because bid costs by category are often constructed as an average of the people in a given category, high-end personnel cost more than the bid and contracted rate. This leads to losing money (spending nominal profits) for such categories. The more hours that are worked by such personnel, the more money is lost. A PM who is not aware of this possibility will be in for a significant shock when management declares that the contract may not have overrun total budget but has spent corporate profits.

A cost report that might be used to monitor a T&M contract lists the specific people, by name, together with their actual costs, and compares these costs, by hour, with the rates in the contract. When the contract rates are higher, a profit is achieved. When the contract rates are lower, the contract is losing money.

For example, assume that three senior engineers are working full time at hourly rates of $61.18, $67.35 and $64.82, with the contract rate for senior engineers being $65.50. This means that the project makes money each hour for two people (in the amounts of $4.32 and $0.68) and loses money each hour for the third person ($1.85). On a weekly basis, the reader can confirm that the total profit for the three engineers will be $126, but only for all three engineers working 40 hours each week.

It can be seen that considerable up-front planning is required in order to staff a T&M contract. It is not necessarily a terrible circumstance to be losing money on an individual, as long as, in the aggregate, the contract is making its nominal profit across all assigned persons. The mixture of people and rates, and the often dynamic nature of assignments over time, however, make it critical that all new assignments be considered on the basis of cost as well as capability to do the job. If such a contract is long-term, perhaps several years, it is standard practice for a company to escalate the rates from year to year in its bid so as to cover salary increases and thereby avoid the problems cited. Within certain boundaries, customers will accept year-to-year rate increases as a normal way of doing business. In all cases, the PM must be aware of the form of contract and the specific provisions of the contract that must be satisfied. For this reason, as a project plan is about to be prepared, it is recommended that the PM sit down with a ''contracts'' person and make sure that all the key contract requirements are understood.

Corporate Rate Changes. Many a Project Manager has been surprised when corporate rates have changed at midstream in a project, causing unexpected cost increases. Although these are usually not the responsibility of the PM, increases in corporate fringe, overhead, and G&A rates can force the PM to ''make up'' for the problem by finding ways to reduce future costs. For at least this reason, the PM should track these rates in cost reports and also try to keep abreast of overall company problems that might cause rate increases. This type of unexpected change also reinforces the prudent action of keeping reserves whenever possible. The cost elements that impact fringe, overhead, and G&A rates are shown in Exhibit 4.1.

Exhibit 4.1: Fringe, Overhead, and G&A Cost Elements

A. Fringe

1.

Sick Leave

2.

Holiday

3.

Vacation

4.

Severance

5.

Compensation Insurance

6.

Unemployment Insurance

7.

FICA Tax

8.

Group Insurance

9.

Travel Expenses

10.

Recruiting

11.

Training

12.

Employee Pension

B. Overhead and G&A

1. Salaries and Wages

1.1 Indirect Labor

1.2 Other Compensation

1.3 Overtime Premium

1.4 Sick Leave

1.5 Holiday

1.6 Vacation

1.7 Severance

2. Personnel Expenses (see ''Fringe Items'')

3. Supplies and Services

3.1 General Operating

3.2 Office and Printing

3.3 Utilities

4. Fixed Charges

4.1 Depreciation

4.2 Equipment Rentals

5. Office Space Facility Rental/Mortgage

Reserves. It is strongly recommended that a PM keep a cost reserve, especially on fixed-price contracts. Suggested amounts are (1) 2 to 5% on cost contracts and (2) 8 to 12% on firm fixed-price contracts. The basic idea, of course, is to plan to perform the contract for an amount equal to the base contract value less the reserved amount. Selecting a precise reserve percentage, given the preceding ranges, should be based on the risk analysis and particular circumstances surrounding the project. However, on a cost-reimbursible contract, reserves can be given up as the project approaches completion unless there is a specific incentive fee for underspending the original cost budget.

It is also prudent for a PM to ascertain whether upper management has also taken reserves on the project. This will normally affect how much reserve the PM should set aside.

Cost Item Limitations and Trades. Some contracts contain explicit limits on certain cost items. For example, limits may be placed on travel, consultant services, and various categories of other direct costs (ODCs). Here again, the PM must be aware of these limitations and control these costs so as not to exceed the limits. This also raises the question as to whether the PM may ''trade'' one type of cost for another. To illustrate the point, suppose it turns out that only $6,000 is needed for consultant services when the original plan and budget estimated a requirement for $8,000. Unless the contract prohibits such action, the PM is normally free to move the $2,000 difference to, for example, the direct labor budget in order to obtain additional hourly work, if necessary. A good rule for the PM to follow, where actual expenditures differ from budgeted expenditures (and they usually do), is to check the contract provisions to assure that all changes are made in consonance with the terms and conditions (Ts and Cs) of the contract document.

Cost Graphs. It is also recommended that the PM convert project cost report data to graphs of monthly and cumulative expenditures, compared to budget, for various categories of cost. This may be achieved by taking data received from accounting/finance and feeding them into a spreadsheet that has a graphing capability, which most of them do. The purpose is to be able more readily to ascertain cost slopes and trends. This is usually difficult to see with a large set of numbers in a tabular format.

Cost Reporting to Customers. The customer usually requires some type of cost reporting on a periodic (e.g., monthly) basis. Exceptions might include fixed-price contracts. Such reports are usually prepared by accounting/finance, go to the contracts department, and from there are sent to the customer. Often, the PM and PC are out of the loop for this type of reporting. This is not a recommended practice. The PM and PC, as a minimum, should be given copies of all reports sent to the customer in satisfaction of contractual obligations. A more desirable practice is to assure that the PM and PC concur with the cost information that is being sent to the customer.

It is emphasized that all contractual cost reporting requirements should be meticulously satisfied and the PM should attempt to assure that this is achieved, even when company procedures do not keep him or her ''in the loop.'' At the same time, the contracts department should list and check all contractual deliverables and contact the PM and PC to determine and confirm status. For example, some cost contracts require that an anticipated overrun in cost be flagged for the customer when expenditures reach 75 or 85% of the contract value. The PM and PC should be best qualified to determine whether or not such an overrun is expected. If they miss the flagging notification, the customer may not pay the overrun costs. A good contracts department tracks the situation and alerts the PM and PC as to the flagging requirement. Good communication between PM, contracts, accounting/finance, and the customer is thus seen as critical in order to achieve project success.

Project Management Made Easy

Project Management Made Easy

What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.

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