Less Discussed Topic?
Recently I came across a question for some help from a project manager over a PMI discussion forum about a request he has from his management.
The question was: How can I prepare the detailed “what if” versions of the project financial plan, specifically the final project gross margin, based on the individual cost rate of resources to be involved to deliver?
The question was not very firm what kind of challenge in the preparation of the information the asking PM had, but it sparked a major discussion on how detailed a cost rate for the project resources should be defined.
Most of the responders to the question criticized the management request as insane or at least impractical, as “…nobody does this…”.
The resources cost rates definition is not a topic project managers have to deal with – as a principle.
We all assume they are defined by the finance department or sort of back-office and we take it as given.
But for many business models and professional services firms how the cost rates are defined is as important as billing rates.
Why, because no matter what pricing method we approach for the project, knowing cost based on workload and resources proper cost rates is essential.
Let us take a look at the topic.
Most responders who criticized the management request for individual resource cost rates were advocating "role-based" resource cost rates.
And this is a very practical approach indeed.
In short, the company defines a generic role, like analyst, developer, tester, installation consultant, service consultant. so on.
Then assign cost rate to that role. No matter who will perform the job on a project if he plays the specific role his cost will be charged accordingly.
The list is published in a company and everybody who needs to calculate cost based on resources can use it.
It is also easy to manage the financial execution of the project.
If you change one physical person - analysis to another person the same role, your estimated cost at completion is not changing (providing workload is the same) as both resources, use the same cost rate.
"For a service delivery company defining proper cost rates for resources are as important as defining the right billing rates"
The trick is how general on roles we are. And even more how well we calculated the role cost rate.
I know quite large organizations use one flat cost rate for their internal resources in project calculations. Everybody, literally from tester up to program manager, has the same rate per day (not even an hour).
They made it even simpler.
That "one cost rate" is simply a market-based average rate from specialists blend on their market. It is not calculated based on the real cost of employees.
It is an extreme case, but it works for them as they don't care that much how accurate the cost rates are. The assumption is that the potential difference is not worth calculating.
But please mind I am not talking about commercial organizations living out of delivering services.
Those large organization's core business is elsewhere than delivering services and projects.
But if you are a supplier and you do live out of delivering projects, the above example is almost completely not unacceptable.
The main issue is how an organization is coming to a specific resource cost rate for the role?
Let us then at the Fully Loaded Cost Rate.
Fully Loaded Cost Rate
This model assumes there is a detailed calculation of what a specific resource’s cost rate is.
In an ideal world, It would be the best model for project and service suppliers. But not necessarily easy to implement.
Ok if your team is 20 people. But if You are a multinational organization and have many branches in different countries it is more challenging.
What is a fully loaded cost? Fully loaded cost for the resources should include all cost assigned to resources per year, like:
- Salary and bonuses
- Training cost
- Employment bonuses (health care, insurances, cars)
- Management overhead
- Proper billability capacity
- Administration overhead uplift
All this should be melted in a pot to produce a proper cost rate per person.
Hard Work? Massive work? Probably.
Because it gives the right accuracy.
In one company I used to work for, they did this every year, of course having the right worksheets to provide calculation. The process requires some resources but it was not killing. Also performed year by year it gets more efficient.
Out of two approaches, it seems to be very practical to use role-based cost rate calculation.
But too much generalization on resource cost rates by role is a potential financial problem to an organization and may result in poor financial results.
Individual Fully Loaded Cost is more desirable but may be overkill for some large organizations.
So, what would be the recommendation here? A Sweet Spot.
I advocate role-based as well as other people on the discussion forum.
But with the right calculation beneath roles.
What is the right calculation?
Knowing the real cost of the organization and real administration overhead (not billable people) is key.
Also making sure the same role is not performed by people with a big salary gap.
I think the good rule is a 15% gap maximum.
Once we have proper cost rates, calculating project right cost and price should be “bread and butter”.