ESTIMATING FROM FIRST PRINCIPLES: 3 REASONS WHY

All contractors are faced with the challenge of having to continuously procure new work whilst attempting to maximise their profits. These two objectives are often contradictory – higher profit margins will typically procure less work, and vice versa. A balanced approach is key to a sustainable construction business.

Developing a well defined and accurate cost estimate for a project is therefore one of the first and most important steps in this process. Several different methodologies exist. This post will explore the advantages of following a so-called first principle approach to cost estimation.

WHAT IS FIRST PRINCIPLE ESTIMATING?

First principle estimating refers to the process of calculating project-specific costs based on a detailed study of the resources required (Labour, Equipment, Material, Subcontracts etc) to complete each item of work contained within the project scope. Productivity assumptions are applied to all labour and equipment costs with adjustments made to account for project specific site conditions.

A plastering example is given below:

Bid Item: Plastering of Interior Walls (Unit of Measure = m²)

Rate Breakdown

RESOURCE UNIT RATE UOM TRANSFORM FACTOR RATE/m² Labour: General Labour £100.00 /Day *3[workers]/25[m²/day] £12.00 Plasterer £150.00 /Day *1[workers]/25[m²/day] £6.00 Material: Mortar (pre-mixed) £130.00 /m³ *0.025[m³/m²]*1.15[%waste] £3.74 TOTAL RATE/m² £21.74

The breakdown of the rate is clearly communicated. Resource requirements are stipulated, production rates are documented and wastage allowances are apparent.

This methodology stands in contrast to the so called unit/plug rate approach to pricing, where estimators rely on historic pricing libraries to directly populate unit rates of a bid.

UNDERSTANDING THE TRUE COST OF CONSTRUCTION

Even though the scope of work is often quite similar from one project to the next, the cost of construction is still highly dependent on specific site conditions as well as the quality, availability and cost of a contractor’s resources.

An accurate estimate will need to account for these project/company specific variances. This is easy to do when an estimate has been developed from first principles, because the rate breakdown can easily be inspected and revised, thereby ensuring that all resources and assumptions are valid and applicable.

However, adjusting historic estimates that are based on plugged unit rates can often be challenging and will rarely be accurate. This is because of the difficulty of gauging the impact that a specific variance might have on a unit rate, especially if the assumptions used to develop the original rate are not clear to begin with.

Following a first principle approach will give you confidence in your final estimate by ensuring that all construction costs specific to your project are known and have been accounted for.

STANDARDISING OPERATIONS & COMMUNICATING ASSUMPTIONS

A well defined estimate and project plan serves as a blueprint for project execution. Ensuring that all of the assumptions and decisions made during the pre-construction phase of a project are clearly documented and communicated to the on-site project team is of vital importance to ensure a project finishes on time and within budget.

First principle estimates have the advantage of being self documenting and self explanatory. Resource requirements and allowances are apparent for each bid item, requiring minimal explanation or documentation to be executed according to spec.

Contrast this to the situation where the project team is provided with a high level unit rate estimate only. Unless additional documentation is also provided, the on-site team will be relying on their own experience and estimates when allocating resources and monitoring production.

A well defined first principle estimate therefore provides the on-site project team with a clear execution plan that will incorporate all assumptions and learnings of the pre-construction team.

POST TENDER BUDGET MANAGEMENT

Construction projects are often executed over a long time frame and with relatively thin profit margins. It is therefore imperative that cost control should be done on a continuous basis, rather than waiting for project closeout to assess profits or losses.

Effective cost control requires a system that will allow for the comparison of actual costs against budgeted expenditure at any point during the execution of a project. This process can be complex, as it requires data from cross functional departments, each with their own reporting formats. Ensuring that your original project estimate is structured in a way that facilitates cost control will greatly simplify this process.

The resource based structure of a first principle estimate is perfectly suited for cost control. Seeing that construction costs are typically incurred against resources (materials are purchased, equipment is hired, wages are paid etc), a first principle estimate can be reverse engineered to produce budget allowances against these same resources – enabling an apples vs apples comparison.

Referring back to the plastering example, assume that 20m² of plastering has been completed one month into construction. By inspecting the original rate breakdown, we can easily calculate both the quantity and the budgetary allowance for each resource to date:

Allowed Quantities to Date:

General Labour = 20[m²]*3[workers]/25[m²/day] = 2.4 worker days

Plasterer = 20[m²]*1[workers]/25[m²/day] = 0.8 plasterer days

Mortar = 20[m²]*0.025[m³/m²]*1.15[%waste] = 0.575 mortar m³

Allowed Budget to Date:

General Labour = 2.4[days]*100[£/Day] = £240.00

Plasterer = 0.8[days]*150[£/Day] = £120.00

Mortar = 0.575[m³]*130[£/m³] = £74.75

For each of these resources, the actual quantity procured and actual cost incurred should already be tracked in an organisation’s accounting or ERP system. A detailed budget vs actual comparison could therefore be done on a continuous basis, highlighting potential production issues or resource wastages before they become serious issues.

This resource driven approach to cost management is only possible if estimates are structured according to the first principle pricing methodology.

CONCLUSION

The advantages of the first principle estimating methodology should now be clear. By requiring estimators to perform a detailed study of a project’s resource requirements, whilst documenting all assumptions, the methodology not only provides highly accurate pre-construction estimates, but also provides an execution blueprint for the operational team that can automatically form the basis of continuous cost control.

The high level of input and detail required to set up a first principle estimate might seem time consuming and labour intensive, but the final return on investment will far outweigh this initial effort.

Also, this burden can be alleviated to a large extent by making use of a specialised first principle estimating platform such as Lula Build, which provides advanced tooling to ease the process of setting up a first principle estimate, either from the ground up, or by repurposing previous estimates. Detailed resource reporting is also supported out of the box, simplifying forecasting and cost control.

We will be posting several articles about first principle estimating in the coming months, so please sign up to Lula Build and stay up to date with our latest content!