Now, let's look at cost based pricing through an example. Now, this is this example is taken from one of the projects that we have done though I have not stated the name of the project and use some figures which are approximates, but this is more or less only a real case. So, how we basically go about doing cost based pricing is explained here, the method may be different for different firms, because the concentrations will be different, especially, the method may be different for large firms, where the concentrations are far different from what a consideration we have for a small firm like ours. Now, what we do is we are in support we are supposing that the project which we are dealing with has two modules which we have to deliver. Basically we have broken down the entire project into two parts, which we will have to deliver to the customer.

Now, we would do estimation for each of the modules normally we use methods like function part analysis if it is not possible to apply for Porter analysis for a lacking of details, we may go for other methods as well. However, what is what is important to determine in a project like this is that how many number of bad months we will consume to deliver the project because the number of man months will determine ultimately what is the driving force behind the price we will charge so, we go ahead and find the number of man months required to develop tests implement the project. Also we find the number of man months required during the warranty period, etc. Now, after we determine the number of man months, every man month will require maybe a different charge because we will be requiring different levels of skills and the different level of skills may require different amount of money to be paid to the people.

So we find a blended man month cost for the project. Now we can apply the blended bandwidth costs across the entire project through all the resources that will be required during the project. So, that's why it is important to find the branded bandwidth cost on top of the blended mammoth cost we add the operational overheads. Now, the operational overheads are very important to add because this cannot be recovered from any other means other than from the projects that we are delivering. So, the operational overheads typically constitute competence like the office rent which we pay or the computers which we buy, the salaries that we pay etc. Now, there are some operational overheads which are coming from things like the directors salary because the directors etc contribute a lot to the projects in the organization.

However, they are not returning the money through directly to the company through earning for that. So, we will have to consider all these in the organizational or operational cost. On top of that, we also add Pre sales activity cost. Now pre sales activities required for every project in the projects don't walk into your office and happen, we have to do a reasonable amount of work pre sales activity require that we meet the customer it involves foreign travels etc, which is a substantial cost. So we recovered through the projects. Lastly, we add a risk contingency.

Now every project has got some risks and the risk may materialize and not finalized, but the chances are very high the risk normally materialize in almost every project. So we find a fund which will be risk contingency which you add to the project budget, so that it can be taken care of by the project itself. Now let's put the method what we have discussed just now into some numbers to understand it much better. Suppose that we estimate that the module one will take 16.55 band months to develop and test On a calendar period of three months, now, we have identified that this project This module will require one analyst for developers to testers and a project manager. So, and we have also stated the approximate cost of each of the type of resources resource. Now, typically, we will have a situation where let's say when we are using for developers, all the four developers may not cost the same.

So we may have to get down to more granularity in this regard, I have taken a little simplistic case, okay. And this figures are though I will not say industry standard or something like that, but this is pretty much close to what was the case in our project. Now, when we add up all the cost, this is the salary which we will be paying to the resources. So when we add up all these costs, it is coming to round about 23.9 lakhs Indian rupees So, this is the salary cost we can say for developing the module one. In the same way, let us suppose that the cost of development and testing of the module two is 15 lakhs. So, we have determined the cost what will be required to develop the modules.

Now, look let us look at the operational overheads Now, every organization will have some operational overheads and this operational overhead has to be recovered through the projects or services what they are rendering because there is no other means to recover this overheads and these overheads cannot be forgotten, they have to be spent or expensed. Now, the thing is there are certain overheads which are fixed like office rent, for example, is a fixed expense. Now, this office rent has to be paid on a monthly basis or annual basis as a as per the agreement with the company of throughways. The Office has been taken. Now other facilities like computers etc, which are long term assets. Now the computers for example, in our case we buy the computers and we give them a shelf life of three years.

So we spread the expense on computers across three years of time. There are other expenses also which we have to include like executive staff salary, for example. Now, this is I would like to talk before the salary is paid, we pay to the directors, marketing, staff, etc. There are other admin staff as well like the delivery boy etc, who salaries after we accounted for. So all of these costs put together this is the case I have given for our firm is coming to a little bit more than one corrode. Now, we have to recover these costs from the job is that our project people or the technical staff conduct and we assume that they are number is 25 an hour company at this point of time and so, dividing by 25 we get that we have operational overhead of purchase head at 36,000 rupees, which we have to recover through projects.

So, so far we have determined the salary cost for developing the modules and also we have determined the operational overheads. Now, let us put these two together to find the actual cost what we have to recover for developing the modules. Now, we found that the salary costs for module one was 23 lakhs 90,000 and we would be taking 16.5 man months to complete it. So, per man month the salary costs for module one is coming to around about 1.45 lakhs. Now, the up adding the operational overheads on top of this we find that the bandwidth rate at which we should consider for development of Module One is coming to 1.81 lakhs so using the blended rate of man month For module one, we'll find that the cost of Module One is coming to around about 30 lakhs. So, similarly, let us consider the blended rate for module two is 1.6 lakhs and it will require 12 man months to develop, then the cost of module two would be coming to 19 lakhs ext we determined the implementation cost.

Now, we have taken a case where we have considered that the implementation is in a foreign country. So, all this while we are considering that the project is being developed in India and the implementation has to happen in a foreign country. Now, we are another point for you to notice that we have been discussing all the numbers in Indian rupees, you can use the same concepts and utilize your local currency to apply and determine the costs. Okay, one more point I should point out is that we are discussing a lot of numbers. So, you can pause the video wherever you Want and do some calculations yourself to and to understand the concepts much better Okay, coming back to implementation cost, we consider that we required one month to implement a software and during that one month we will be requiring three full time resources. We have taken a simplistic way here and we say that the blended rate for man month per resource is going to be 1.7 lakhs Indian rupees.

So, the cost of salary comes down to 5.1 lakh Indian rupees 1.7 lakhs multiplied by three resources is 5.1 lakhs now, the resources will have to be traveling on site. So, besides the salary what they will get in India, they will also be getting some travel expenses to survive in the foreign country. Besides we will have to purchase a tickets and we'll have to procure visas, etc and also will have to pay for their hotel costs. So, we have taken a figure Which we stated here like one like for air tickets and visa for seven lakhs for hotel and six lakhs for travel expenses travel allowance. So, all these things totals to 14 lakhs. So, the total implementation costs is coming to 5.1 lakhs plus 14 lakhs which is equal to 19.1 lakhs like we discussed previously, we would be having some cost when we are giving the during the warranty period of the project.

Now, we consider that the warranty period for this particular project is for three months from the date of go light during the warranty period we will have to deploy some resources who would have to be attending to the different requirements of the customer in case the software is misbehaving. Now, there are some resources which will be generically used across the organization for all the customers like for example, the service desk for level one. So, level one service desk is shared across all the different projects and they do the routing after depending on which resource has to be recorded called for which project. There are some other resources also which we shared like for example, the DBS we don't require dedicated DBA for every project, we can share the DBA across different projects Same goes with system administrators for Linux or for Windows and etc. Now, we do not get into the calculation of warranty period cost on a man month basis, instead we just say that we will take 30% of the development cost as the volunteer period cost.

So, doing that, we consider that the development costs was 49 lakhs 30 lakhs for module one and 19 lakhs. So, module two that adds up to 49 lakhs 30% of that comes to approximately 15 lakhs. So, we will say that the r&d cost for this particular project is 15 lakhs next up we come to the risk contingency like we know In every project and the many risks, so, let's take for example a few technical risks which we understand as an example, for example, the changes may the changes will be provided required by the customer once we are in the acceptance phase that is development is over and the acceptance testing is going on with the changes are required by the customer. So, this will normally resulted a longer implementation period or maybe coming back to the development and doing some work as well. So, this is a huge risk which every project carries.

Similarly, the customers generally by default in terms of providing the right environments on which the system can be deployed, which will also increase the stay of the people on the on site if it is a requirement to be deploying from on site. There may be changes in data, which is very vital because data migration is normally taken or taken on during the implementation phase. So, we do the hard work of through sample data during the development stage, but it is mainly during the implementation stage that we come across the actual data. So, this may throw up some surprises like some data which we may not have considered etc. So, all of these things can lead to delay in the project being completed and which means the duration of the project is increased which and increasing duration of the project results in extra cost on the project.

There can be other risks for example, if you are sending a project to a foreign country and there is a fluctuation of currency exchange rates that can lead to substantial amount of change in the amount of costing which we have done. So, we always keep our ways contingency fund which can cover for such kind of eventualities. Now, risk contingency fund calculation is not a very easy exercise it requires a whole Chapter by itself. For simplicity case, we will say that after doing all our calculations, we have come to the conclusion that we will take 20% of the project cost as risk contingency. Now, we will consider for this particular case only the development and implementation cost to be considered for taking into this consider risk contingency fund. So, we say 1249 lakhs for development 19.1 lakhs for implementation 20% of that is 14 lakhs approximately.

So, we will keep a risk contingency fund in this particular project for 14 lakhs. Another important concept to consider in our firm is the cost we incurred during the pre sales stage of the project. Now, the pre sale stage we normally try to do it online through using modern media like Skype Viber when we have to give demos etc. However, there are some meetings which we cannot forego, and especially if it's in a foreign country, it is cost cost. Bit to us, because we have to get air tickets, resorts and hotels and everything. So, high profile meetings which are required with the customer, we do it on site with the customer these So, likely like I said this is substantial cost and this is the investment which we do to get a project.

Now, for simplicity sake for this particular case, let us say that this pre sales cost which we incurred is around about 5.9 lakhs, now, that we have determined all the costs, let us put them all together. So, we had a development cost of 49 rupees 49 lakh rupees for the two modules, implementation cost of 19.1 lakh rupees and a warranty cost of 15 lakh rupees, we add this up and it comes to at 3.1 lakh rupees. We will see shortly why we are doing this separately. Next we also had the pre sales cost of 5.9 lakh rupees and a risk contingency we had capped off 14 lakhs. So now adding 83 lakhs with these species In this contingency, we see that the total cost is coming to one crore three three lakh rupees. The last step in determining the price at which we will sell to the customer in cost based pricing is to add the profit margin.

So, now, suppose for this particular case we say that we want to make a profit of 20%. Now, we add the we calculate the profit based on the cost we have towards development, implementation and warranty, because here is where we will be spending our man months we did not take the risk contingency and pre sales cost but however this can vary from company to company, what's your policy how you do it is all dependent on you. So, we take only the development costs, the implementation cost and the warranty cost on top of which we will compute the profit. So, we want a profit of 20% all of 83.1 lakhs this comes to approximately seven In lakhs, so, the price at which we expect to sell to the customer is the total cost of 1.3 1.03 crores plus 17 lakhs that is coming up to 1.2 crores.

Now, the profit margin is the thing which we can easily make more or less depending on the customer. Now, this is also gives a cushion like we can use this profit margin as the margin on which we can negotiate to the customer. But normally, every salesperson will add a little bit on top of the price which he wants to charge for as a negotiation margin. every customer in the world negotiates the price and so we should keep some margin in our hand, which we can use to negotiate the price and reach the price that we are desiring to get. So, there's been a lot of numbers. I hope you could go through and please go revert back to this video and check and understand the concepts very clearly.

And I hope this has given you a good idea of how we do cost based pricing. Thank you see you in the next lecture.