Project Management Institute

You can't negotiate cost

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by Mark Durrenberger, PMP

YOU MIGHT THINK the difference between price and cost would be well understood in any capitalist society. We learn from an early age that the goal is to buy low and sell high. In other words, we want the largest possible difference between cost and price. We call this difference “profit.”

Price is a characteristic of a product or service that is determined by market forces and what a buyer will pay. Price is flexible and negotiable. Cost is defined here as “the expenditure of something, such as time or labor, necessary for the attainment of a goal.” In the context of projects, cost is inherent, non-negotiable, and largely dependent on scope. Here's an example of a boss who doesn't understand the difference between price and cost:

Boss: Now that we've agreed on the scope of this task, how many hours will it take you to complete it?

Worker: Based on my experience, I think it will take 15 hours of effort.

Boss: That's too many. I'll give you 12.

Worker: But I just told you the estimate; it'll take at least 15 hours.

Boss: Well, the most you can have is 13.

Have you ever been in our worker's situation? Let's explore what happened.

Based on experience, the worker made an estimate of cost (in terms of effort-hours) for the activity. The boss thought the number was too high and made a counteroffer. The worker didn't budge (smart move!), so the boss countered again.

While this conversation may seem normal, something odd is going on—the boss is trying to negotiate the cost of the work. Does this make any sense? Imagine going to your local car dealership to buy a car. Except that, instead of negotiating over the sticker price, you try to negotiate on the dealer's cost. No matter how hard you press, the dealer can't lower the cost. Why not? Because the cost is the cost. It's money the dealer had to spend to get the car on the lot.

So, what's the result of “cost” negotiations? Normally, the worker pads the estimate. This leaves the worker some room to negotiate. As long as the agreed-upon number is greater than or equal to the actual effort needed to complete the activity, the work can be delivered without the worker suffering the pain of going over budget.

Mark Durrenberger, PMP, is a founding principal with Oak Associates Inc., a project management consulting and training firm based in Maynard, Mass. In his work, he regularly helps project managers avoid negotiating cost on their projects.

The negotiation of cost turns the estimating process into a game. The boss assumes that the worker is padding the estimate and tries to extract as low a number as possible. The worker assumes that the boss is going to negotiate cost, and holds out for enough hours to complete the activity while maintaining quality. The resulting estimate is based on the negotiation skills of the two parties, not on the work.

As you might know from your own experience, negotiation is a lousy way to estimate. Stakeholders should treat activity cost estimates exactly as car dealers treat their costs. Costs cannot be negotiated;they are the hours necessary to get the work done.

A student recently asked, “But I always pad my cost estimates because my boss always negotiates. How do I break the cycle?”

The answer: “Use a range-estimating process.”

To maximize the value of the range-estimating process, both the boss and the worker should understand and know how to use it. (To get both the boss and worker up to speed with range estimating, see “True Estimates Reduce Project Risk,” [PM Network, May 1999] or download it at www.oakinc.com/pdf/estimate.pdf.) The range-estimating process results in four cost numbers: three estimated values, referred to as optimistic, likely, and pessimistic cost; and one calculated value, referred to as expected cost (assuming a triangular distribution, expected cost is the average of the optimistic, likely and pessimistic values.)

How does range estimating change the negotiation? Let's revisit our earlier conversation:

Boss: Now that we've agreed on the scope of this task, how many hours will it take you to complete it?

Worker: Typically, this type of activity takes 12 hours. If things go really well, I can complete it in 9 hours; but if things go poorly, it could take as many as 24 hours.

Boss: Just give me one number!

Worker: Well, the average of the three estimates is 15. But remember, I only have a 50-percent shot at hitting that number. Are you willing to take that risk?

Boss: No! This is an important activity. Can you give me an 80-percent number?

Worker: No problem; that'll be about 18 hours. (80-percent value approximation = expected cost + pessimistic cost – optimistic cost /5).

(Caution: Do not add up all the 80-percent activity numbers to calculate a project total. To add up the ranges, see “True Estimates Reduce Project Risk,” referenced above.)

SO, THE NEXT TIME one of your stakeholders tries to negotiate a lower cost, gently reiterate that your estimate is not a price range, it is a cost range. Costs are based on the work to be done, and the work to be done is what it is. If the stakeholder still wants to negotiate, say that you'll be happy to quote a price (provided you get to keep the profit). ■

Reader Service Number 173

This material has been reproduced with the permission of the copyright owner. Unauthorized reproduction of this material is strictly prohibited. For permission to reproduce this material, please contact PMI.

September 2000 PM Network

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