Project Management: Cost vs. Price

Abstract

Associated to every project, however small it may be, there are always costs associated when trying to manage the project and a price for which we want to sell it. This article will present a review of how cost and price can be related to project management, what is the importance of each one separately and the importance of a good relationship between these two factors. A good harmony between them might be a key of the project success and at the same time the cause for unsucess. Therefore, in this article there will be a reflection about how cost and price relationship can be interpreted and support a good decision making. Decisions factors and decisions methods that a company needs to take into account when pricing a project or select which costs are avoidable and which ones are necessary, will also be explained along the article. The project's quality and profit are also two terms directly connected to the relationship between cost and price of every project, the way the customers evaluate a project's value from its price and the costs that are necessary to incur to sustain a certain quality of the outcome are also relations that will be further discussed here.

Key Concepts

Cost

By definition cost is the amount of money that is spent in acquiring any good or paying for a service. There are two types of costs, the direct and indirect costs. The direct costs are related to the actual expense that they represent, the act of spending money in exchange of something, i.e. buying a software or equipment. The indirect costs are usually hidden beyond the the cost of a product or service, for instance, the cost of hiring a cleaning service to the office or even the rent. These costs can be classified as fixed costs, where the value does not change - office rent, salary of employees or the cost of the cleaning service if we have a contract for a fixed number of hours, or can be classified as variable costs where there is a chance of the value to change, such as the office's bill of gas or electricity - Figure (COSTS)

Price

Price can be defined as the quantity of money, or a compensation that is given from one part to another in exchange of any good or service. The price that a costumer is willing to pay is directly related to the value that it attributes to the commodity or service. Of course, not every customer has the same perception of value about something, and this is the reason why the companies need to be careful when pricing their products. The process of finding a price that fits the market and it is not above nor below the customers expectation will be further discussed - Pricing Strategies (PUT THE LINK HERE). The price of a product or service is not only directly related to the perception of their value, but it is also associated to the customers perception of quality of the product. The price is really sensitive to the market conditions and the - (THEORY OF PRICE) - explains how the price can be related to the relation between the supply and demand.

Profit

Defining profit is almost the same as defining a company's purpose to enter in the market. The profit is as simple as the difference between the price for what we sell what we product and the costs to produce it, i.e. the profit is the part of the money that is earned by the company when selling a product or service. For instance, let's suppose that a company spends 5DKK in producing a pencil and they sell the same pencil for 15 DKK, this action of selling the product will generate a profit of 10 DKK to the company.

Quality

According to the definition of Oxford English Dictionary, quality can be defined as "The standard of something as measured against other things of a similar kind; the degree of excellence of something.". When managing a project, to ensure the quality of the final outcome is one of the most important objectives of the manager. Quality is one high weighted factor that can distinguish a project from others of a similar kind and probably allows the project to be chosen among the others. The project's quality is directly related to its price and sometimes it is also related to the costs that were incurred to manage it - if the process was effective and efficient there were not unnecessary costs.

Application to Project Management

Project Cost Management

In order to a project to be completed within the approved budget limit it is needed to plan the overall costs structure before it starts: estimating the costs, creating a budget, developing a plan of funding financing and managing, and develop a plan of costs control. The main objective of plan in advance all the processes is to make the project as the most efficient - regarding costs - as possible and so, avoid the bad use of money. The action of planning the costs is mainly concerned to the cost of the resources needed to finish the project. It also helps to making important decisions regarding all the project procedure, for instance, the number of times that the project design needs to be reviewed. ( BOOK REFERENCE PAGE 233). Project Cost Management is simpler to develop if the project's scope is well defined since the beginning once it is easier to preview all the processes and do the detailed cost calculation, but if it is not defined or it presents a high level of uncertainty, methods of cost estimation can be more general and it is created a plan that can be easily changed. Project Cost Management consists in four steps as it is described in the figure (FIGURE WITH THE STEPS). Each of these steps is composed by a group of specific techniques that transform the inputs, that in many cases are results from previous project planning processes, in outputs that when grouped together will define the Project Cost Management.

Planning the costs of a project consists in defining how the costs will be estimated, controlled, financed, managed and budgeted. Plan Cost Management is also where is decided which, how and how many resources are going to be applied to each process. The procedure of planning costs has as output the elaboration of a cost management plan that is obtained throughout the techniques as expert judgement, data analysis and meetings that uses inputs as organizational process assets, the enterprise environmental factors and the previous developed project management plan and project charter. ( BOOK REFERENCE PAGE 235-239)

Estimating costs of a project consists in building an approximation of costs of the necessary resources to complete the project. Estimate the costs is a process that it is done several times throughout the project and adjusted in as changes arises. Estimation is a complex process that requires the use of specific mathematical models and techniques as: analogous estimating, parametric estimating, bottom-up estimating, three-point estimating, data analysis, project management information system, decision making and expert judgement. All these techniques uses similar inputs as planning costs, like project management plan, project documents, enterprise environmental factors and organizational process assets, and throughout these tools it results in project documents updated and in overall cost estimations and its basis. ( BOOK REFERENCE PAGE 240-247)

Determine the budget consists in grouping all the cost estimations from singular activities and create a cost baseline to be further authorized. This cost baseline will allow a cost monitoring during the course of the project, and it includes the contingency and excludes management reserves. Expert judgement, cost aggregation, data analysis, historical information review, funding limit reconciliation and financing are the techniques utilized to determine the the project cost baseline, the funding requirements and the project documents update, from the outputs of the costs estimation plus the company agreements and the business documents. ( BOOK REFERENCE PAGE 248-256) - PUT IMAGE OF COST BASELINE AND PROJECT BUDGET GRAPHS

With the major objective of keeping the costs according to the cost baseline it is needed to monitor them during the course of the project. This cost control process results in five crucial outcomes to the well-functioning of a project: work performance information, cost forecasts, change requests, project management plan updates and project documents updates. The techniques and mathematical models utilized to achieve these outcomes are the expert judgement, data analysis, to-complete performance index and project management information system, and as inputs all the outputs from the budget, the cost estimation and the cost plan are essential. (BOOK REFERENCE PAGE 257-270)

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Pricing the Project

Setting a price for a project is usually done by the company’s marketing department, because in order to set a good and suitable price, its needed to be aware about several factors such as, knowledge about the market demand, how the customers valorize the product, what do they value more and more important how much they are willing to pay for the product. Every company needs to define a pricing strategy – that usually makes part of the company’s strategic plan – that should be aligned with their mission and vision. Defining a pricing strategy reflects the intention of the company when selling the product to the customers i.e. the prices can be set in order to maximize the profit, to establish strong relations with the customers, to try to aggregate the maximum number of customers to the product, to only cover the costs of the production or even to build a company’s image in the market. (REFER THE WEBSITE - pricing strategies)

Price/quality relationship

Customer’s perception of value of a product is directly related to the question that marketers ask when setting a price “how much are the customers willing to pay for this product?”. In fact, this is one of the most important factors of pricing. Regarding the quality of a product, it is usually seen as a proportional relationship between quality and price i.e. high prices are often seen as a synonym of high quality. The highest the level of complexity and uncertainty of the product the more dependent in this price/quality correlation the customers are. According to the authors of “Prestige-Seeking Consumer Behaviours“ the consumers can be divided into four ranked categories regarding their self-consciousness attitude to the importance of price as a factor of prestige. The four presented categories are: Hedonist & Perfectionist, Snob, Bandwagon and Veblenian. The Veblen effect – perceived conspicuous value - refers to the consumers that buy the product based on conspicuous value in order to show status, wealth and power. The Snob Effect - Perceived Unique Value – explains how this group of customers tend to buy the products that are not bought from the majority or when the products are released in the market and only few people have access to it i.e. the scarcity of the product gives a unique and expensive image to the product that leads to the increase of the demand within this group of people.