This is project finance from the standpoint of business project management rather than operations management. The operations management aspect of project finance covers project feasibility in terms of cost recovery or profit once a project is completed and shifts to operations mode.
Meanwhile, the business project management aspect of project finance covers:
- How much expense does a project entails?
- How much is a project worth when sold as a product, service suite or company asset?
- How can companies maximize their profits when they sell their projects?
In-House Project Cost Estimates of Non-Project Companies
An in-house project manager of a company not engaged in selling projects or consulting on project management expertise will make a project costing based on how many hours each staff puts in according to individual wage rates and the cost of resources hourly. Most often though, incidental costs such as the expenses for office space, utilities, office maintenance, furniture, and counterpart company funds for employee benefits among others are not factored in the costing.
Although project finance officers make ROI calculations to gauge the medium or long term benefits of projects for internal company use, many project owners still deem that projects do not need to turn in profits since these projects will not be sold upon completion. Hence, these projects will have cost estimates and ROI computations and yet these will have no clear and definite prices.
Take for instance a new software application developed in-house.
Based on the estimated cost of a project manager, the company accountant books the value of this project on the PM's input which will typically not include the project's incidental expenses.
Should the company be later on sold in whole or in part in an initial public offering (IPO) in the stock market for instance, this software asset will be booked at cost with its corresponding depreciation. In short, the new software application will be undervalued because it is booked at a loss.
Moreover, based on this approach, regular maintenance costs on the software application will not add value to it. Rather, the software application will continue depreciation on a yearly basis until only the residual value is left despite the incremental and modular innovations made onto it which make the software application more valuable.
Of course, it is also necessary to consider that when a disruptive innovation arises that ultimately makes the software application obsolete, then this asset becomes worthless as the obsolete software makes the company uncompetitive under new market conditions.
Project Companies and/or Project Management Companies Traditional Costing and Pricing
In solicited projects, companies compete on price and technical capabilities in their bid tenders. In an unsolicited project, the proponent persuades for a sale based on potential benefits and the scarcity of technical expertise or barriers to entry versus potential competition.
Say, project managers engaged in ventures that sell projects or project management expertise, such as entrepreneurs involved in the catering business and acting as informal project managers for instance, will always consider any incidental costs in their operations and factor these expenses in the pricing of their service offerings.
Typically, if the cost of one meal per person is $10 based on the aggregated cost of the ingredients and food preparation; the caterer will charge $30 or a bill factor of 3.0 to cover the costs of transporting the food, serving these in plates, providing for tables and chairs, paying for the salaries of waiters and/or waitresses, and so on.
Using a base cost of $10, the project price will be $30 per meal. However, the base cost is just a rough estimate of the actual cost.
Perceptibly, the additional $20 is not the net profit since the other costs of a catering contract are accounted in this operating profit margin. Moreover, a minimum number of meals, say, 100, will be required to ensure that the catering contract is sufficiently profitable.
Of course, some caterers will have complex pricing with detailed costs for tables, table cloths, linens, ice sculptures and so on. This ensures that there is a uniform profit margin for each identified cost item. Marketing-wise though, this pricing complexity has a tendency to overwhelm customers in the many options to be decided upon.
Costing, Pricing and Valuation of Proprietary or Highly Specialized Projects
On one hand, say, in a very competitive market condition where there are too many sellers than buyers, the project pricing will be based on market demand. Meanwhile, profits will be based on operating efficiency to keep costs down.
On the other hand, when demand for a particular project is high and yet there are too few sellers due to the highly technical nature of the project or even because other sellers are barred to implement the same project due to intellectual property rights, then such project will have higher value.
Naturally, the projects company providing such highly specialized or proprietary project can price at a premium which can be higher than a bill factor of 3.0. Moreover, its key project staff and work packages that address such technical specialization or patented processes can have costs, for pricing purposes, set at bill factors of 10.0 to 15.0 to properly reflect value. Market demand and the scarcity of technical expertise determine high value.
Project Finance in Business Project Management
Project costing approaches vary depending on the business focus of companies. Companies that sell projects will factor incidental expenses in their costs plus the profit margins. Profit margins meanwhile are mainly dependent on demand, scarcity and operating efficiency. These factors determine a project's price.
Companies that do not sell projects as a business will typically cost their projects minus the incidental expenses. This is mainly due to the lack of entrepreneurial thinking of in-house project managers. However, when a spin off, merger or IPO is in the works, this limited costing approach can lead to the undervaluation of the company based on its assets.
Recommended Readings:
- 10 Most Dangerous Project Managers - Project Risk Management 101
- 10 Marketing Plan Tips for Project Management Marketing
- 5 Disruptive Innovation Myths Debunked
Melvin Tandoc - Melvin currently works for the project management software company that makes 2-plan Desktop and 2-plan Team.
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