There are a number of key pieces of information that are valuable to have in procurement.
Industry trends, market intelligence, and key suppliers are among the most sought after data. In the construction industry, these types of data can help glean strategic insights, but the single most important piece of data I look for is bench-marking.
Bench-marking data allows you to measure performance or cost. For the most part, when we talk about bench-marking, we are talking about historical metrics.
There are many sources for construction bench-marking. All of them work the same way. Pricing and performance criteria is collected from hundreds of projects. These projects are then cataloged or profiled so that you can match your specific project to a bench-marked project.
To use benchmarking correctly, you need to understand a few key factors that may dramatically affect the rates you use.
Cataloging a project according to it’s profile is extremely important.
You don’t want to use bench-marking information from an office building when you are bench-marking a manufacturing plant.
The cost of labor, management, materials, and building systems used on one building type will be dramatically different than another. These differences will have dramatic impact on costs. As such, if you try to use the costs from one you could be significantly overestimating or underestimating the costs for another.
The market forces that are relevant in one geography are not exactly the same as the market forces relevant to another geography.
Labor rates in New York City as an example are not the same as labor rates in rural Arkansas. As such, if you have benchmarking data for Arkansas and you try to apply the same rates to New York City, your estimate will be very far off.
To adjust for this, bench-marking organizations have developed geographic indices. With a geographic index you can use bench-marking from one geography and apply it in another.
The scale of a project can also have a dramatic impact on cost.
Smaller projects tend to have a higher cost per square foot (or square meter) than larger projects. This is so because the costs of mobilization and supervision have to spread across a shorter construction duration. Also, the contract’s profitability needs to be made over a smaller amount of spend compared to larger projects. These factors lead to unit pricing that tends to rise as the scale of the project reduces.
There is a very specific formula that is used to adjust pricing for scale. This formula is known as the Power Sizing Model.
If we were using the Power Sizing Model to find the cost of a building (let’s assume we are estimating the cost of a 20,000sf building (call it Building A)) and we had the cost of another similar building of a smaller size (let’s say a 10,000sf building (call it Building B)). We cannot simply multiply the cost of building B by two. This would not be an accurate estimate.
Using the Power Sizing model we take the Cost of Building B multiplied by the product of the size of building A over the size of building B to the power of the power sizing exponent.
Cost of Building A = Cost of Building B (Size of Building A/Size of Building B)^Power Sizing Exponent
The tricky part of this equation is knowing the correct power sizing exponent.
In engineering economics, this formula is used for estimating the cost of specific pieces of equipment. In those cases, the goal is to achieve a very high level of accuracy. As such, there are several published power sizing exponent factors in industry text books that provide an exact exponent to use depending on the specific piece of equipment you are pricing.
When we use the Power Sizing Model to estimate buildings we use the universal exponent of 0.6. This universal exponent has been called the rule of six-tenths and is expected to achieve estimates that are within 20% accurate. No one quite knows where the rule of six-tenths originated, but it is approximately the average of all other power sizing exponents.
In our example if the cost of Building B is $1.9M, the formula results in an estimated cost for building A of $3M.
Be sure to use this formula on the total cost of the building (not a unit price) or you will get the wrong answer.
If you are working with benchmarking globally, you also have to understand currency exchange.
With few exceptions every country has it’s own currency. If you were to want to develop pricing for a project in Mexico and you were using a reference project from the US, after you have applied all of your adjustments, you need to convert to local currency.
There are a number of sources for currency exchange rates, the most common (used by Google) are Morningstar and SIX Financial.
If you are performing a currency conversion be sure to use the conversion factor from your reference currency to your subject currency. This can be very confusing if you reverse your factors. For example if you are converting from US Dollars to European Euros, the conversion factor is 0.817 (as of 4/23/18). If you were to accidentally reverse those the currency conversion from European Euro to US Dollars is 1.22. Obviously that could be very bad.
Using benchmarking to develop cost estimates can be very effective. If you use start with the right project profile and you adjust for the right factors benchmarking can be a very accurate predictor of cost.
Follow these simple steps and you will generate accurate estimates for your projects.
What about you? Do you use benchmarking? If so, how do you use it? Do you adjust your pricing? If so, do you follow these steps? Tell me your stories.
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