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July 6, 2005 -- I recently read the article on What They Think titled "Why Budgeted Hourly Rates Lead to Bad Pricing". While I have my own opinions about why budgeted hourly rates are not the most ideal way to do price estimating, I disagree with some of the points in this article. Also note that while I work for a company that develops and sells BHR estimating systems, this message is not a general defense of those systems - I acknowledge the potential issues in using "budgeted" hourly rates, which are only estimates, to create overall estimates.
However, I also believe that a properly configured and maintained MIS system that is based on BHR's is capable of producing very accurate cost estimates consistently over time. The key is in configuring and using the MIS the way it was intended, and adjusting your BHR's on a regular basis.

The article states that there are two main flaws with BHR estimating systems.

The first flaw described in the article is that BHR estimating systems effectively treat all costs as variable costs, and in the example it is pointed out how the labor costs of the company do not change whether or not the company produces the job, since the job can be produced without overtime and the company does not reduce the hours of its hourly employees because of short-term slowdowns in work volume. In the isolated example presented, this is true. However, if the
company wins a sufficient number of jobs, it is no longer true that all of them are produced without any increase in labor costs. It is also not possible to directly associate additional labor costs to any particular job, as any method of doing this is more or less an arbitrary decision. I think many would agree that the goal of most companies is to completely utilize all available production capacity, since any unused production capacity incurs costs that reduce profits. Successful companies do in fact utilize all of their production capacity, and typically have to add varying amounts of overtime in various areas. I would argue that a company that focuses on their BHR estimating system being flawed in the way this article describes is
focusing on the wrong problem - the company should be focusing on utilizing all of their capacity instead.

The second flaw described in the article is that BHR estimating systems estimate the costs of resources consumed, while the profitability of the company is based on the costs of resources supplied. While this appears to relate to the first flaw, I was unable to identify what is specifically being missed in estimating the costs
of resources consumed versus costs of resources supplied. More specifically, what is an example of a type of cost that is a cost of supplying resources, but is not a cost of resources consumed in creating the supplied resource? When a BHR estimating system is configured properly, all costs incurred by the company are attributed
appropriately to all jobs. This should include costs such as depreciation, insurance, interest expense, prorated building expense, property taxes, direct labor, indirect labor, payroll taxes, benefits, maintenance, supplies, utilities, and any other expenses associated with a particular BHR. Also, any other expenses that are not
associated with any BHR (usually referred to as "overhead"), should be distributed across all BHR's. Costs that do not include overhead are normally referred to as "Direct Manufactured Costs", and costs that do include overhead are normally referred to as "All Inclusive Costs". In fact, one thing that should be done to continuously fine tune a BHR estimating system is to compare the all inclusive costs incurred as reported by the MIS system with the actual costs incurred by the
company. Differences should be investigated, and BHR's adjusted appropriately to ensure that these numbers match as closely as possible. This process should be performed at a minimum annually, and quarterly or even monthly would be better. EFI offers this service to its MIS clients, and those who have taken advantage of it have learned how important it is.

I do admit however, that the article did accomplish what I think the author set out to do, which was to create concern and generate interest in his publication mentioned at the end of the article. I just hope that readers do some further investigation into the issues presented in this article, before coming to the same conclusions as the author.

Thank You,
Doug Belkofer
EFI