The Cost Vs. Price Conundrum

My associate in Southern California, Bob Lindgren, has been extremely vocal through the years/decades about the myths of budgeted hourly rates, and he recently wrote these thoughts, “If we accept that we are revenue maximizers and also accept (regretfully) that we don’t have perfect knowledge, we ned a systematic approach to predict the maximum price that a client is willing to pay.

The first step is to think about the core of our present process, the estimating system, which turns around budgeted hourly rates (BHRs).  This rethink should involve the people in the firm who have experience with the outside world – usually the CEO (if he/she is involved with sales), the sales manager and the sales reps.  Note that this group does not include the accountant nor the plant manager as their experience is internal not external.  This task force’s mission is to make their best overall estimate as to the average rates in their market – about how much are competitors charging for a 40” 6/C, etc.?  Chances are that the answers are not going to be too much different from the numbers already in the estimating system.”

I would argue (from experience) that if the firm was to calculate their “actual” budgeted hourly rates, there would be no correlation to their existing BHRs. And here’ the heart of Lindgren’s argument, “An extremely important shift in thinking has begun – we now understand that the estimating package is not a cost prediction process, it is an available price prediction process.”

This is CRITICAL.  Most companies create a myth that the BHRs in their estimating system reflect costs of production – and entire processes are built to “try” to make the round peg fit in the square hole.  If we truly understand AND accept that our estimating system is used to create pricing palatable to the market place, we can then start using other methods to measure the costs of production and find ways to maximize our return on investment.

What are those other ways?  More to come. . .

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